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It is very important for entrepreneurs to be able to read and understand the financial statements of their business says Edmonton bookkeeping. If they do not, they might struggle with understanding their finances, which could cause them to make monetary decisions in their business that could affect them negatively. If they apply for leases or loans that they cannot afford the payment on, or if they make decisions about spending money they cannot afford it, they risk running out of money in their business. Since 29% of all failed entrepreneurs say that running out of money was the reason why their business failed, helping entrepreneurs avoid this is very important to their success.
The next thing those business owners should understand is that leases and loans look very different in their financial statements. While both need to appear on the balance sheet, because about sheet tells the overall financial position of the business, loans appear on the asset section of the balance sheet, while leases appear on the liability section. The reason why is because at the end of the loan, an entrepreneur will end up with an asset in their business says Edmonton bookkeeping.
At the end of the lease, entrepreneurs will not end up with an asset, and either has to continue paying that lease in perpetuity or find something else to spend that money on. For example, if an entrepreneur is leasing their office space, they are going to have to pay that lease amount forever. Unless they decide to move, and then they are going to owe lease payments somewhere else. Therefore, because it does not end up with an entrepreneur having an asset at the end, it is the liability of the business.
It is important that entrepreneurs learn to book this in their financial statements correctly because when entrepreneurs do not account for them properly, it can affect their ability to get more financing. Banks are going to want to see an entrepreneur having more loans than leases because at least they are building up the equity in their business. Also, thanks to understanding that when the loan payment is done, an entrepreneur will have an asset to show for it, and also have a bunch of money that they can put towards something else.
With leases, it is just an endless liability that an entrepreneur has to pay. Therefore, when an entrepreneur can show financial institution that they can manage to pay off their loans, it makes them a better candidate for getting more financing so that they can continue to build their business.
By understanding the differences between leases and loans can help entrepreneurs end up booking them correctly on their financial statements, impacting the accuracy of those financial statements. Not only will let impact their ability to get more financing in the future but also the more accurate their financial statements are, the better-informed business owner will be about their finances, allowing them to make better financial decisions.
Once business owners understand that both leases and loans will pair on their balance sheet says Edmonton bookkeeping, they also need to understand the difference between leases and capital leases. If an entrepreneur sees a capital lease and tries to put it into the liability section of their balance sheet because it has leased in the title, they might be impacting the accuracy of their financial statements, which could result in an entrepreneur spending money they do not have.
Even though an entrepreneur thinks that because the name is a capital lease, it is a liability, capital leases are actually legally structured more like a loan then lease. The reason why is because capital leases have the end goal being ownership of that item. It looks like a lease, but there are several things that can change that lease to being an asset.
The first example of why a lease would be considered an asset instead of a liability is if there is a huge discount buyout option at the end of the term. For example, an entrepreneur is leasing an expensive piece of equipment, that at the end of the five-year term, they have the option to buy it out for one dollar. It is almost a foregone conclusion that the entrepreneur is definitely going to buy out that lease for a dollar says Edmonton bookkeeping. Therefore, it is reasonable to say that the purpose of that lease was for the entrepreneur to have an asset at the end.
Another example of how a lease would actually be considered an asset is if an entrepreneur is leasing that asset for more than 75% of the useful lifespan of that asset. Because an entrepreneur is essentially using it almost for the entire lifespan of that equipment, there is little chance that the company that they are leasing it from is going to want it back at the end, therefore the business owner essentially owns it.
Edmonton bookkeeping says the third example is if the present value of the lease payments is 90% of fair value. This is more like ownership than the lease. And not only is it important for entrepreneurs to understand that leases are considered a liability and loans are considered an asset, but the responsibility that an entrepreneur has with an asset is increased then if they lease. Therefore it is an important determining factor to know about.
When entrepreneurs are better able to understand the difference between capital leases and regular leases which are often called operating leases, they will end up being able to book the expenses on their balance sheet more accurately. When they have more accurate balance sheets, entrepreneurs will be able to look at the balance sheet and the income statements and make informed financial decisions. These more informed financial decisions will be able to help entrepreneurs avoid running out of money in their business. But also, having more correct financial statements will help an entrepreneur strategically grow their business so that they can be successful.
