Outsourced CFO | Assets Versus Expenses
When entrepreneurs are learning how to read their interim financial statements like their income statements and balance sheets according to outsourced CFO, they are not appropriately classifying their major purchases, they could end up with interim financial statements that are incorrect or useless. Therefore it is extremely important for entrepreneurs to not only learn how to read their financial statements, but how to classify their assets in their purchases in order to end up with the most accurate and usable interim financial statements possible.
In order to understand how to classify their assets properly, entrepreneurs need to understand the difference between an asset and an expense. Outsourced CFO says that a definition of an asset is a purchase that has a useful economic life of over one year. And an expense on the other hand does not have any significant useful life passed the point of purchase. An example of each would be a vehicle is a great example of an asset because it is going to be used for many years to help an entrepreneur with their business. Advertising on the other hand is purchased and only serves a useful life for the period of time that the advertising is active. By understanding these two definitions, can help entrepreneurs classify them properly.
Something else I can help entrepreneurs save time in classifying their assets, is outsourced CFO recommends that entrepreneurs do not worry about classifying assets that are less than a thousand dollars. While there is many assets that can be purchased that are under thousand dollars that have a useful economic life longer than a year, trying to list all of those assets and then depreciate them on a yearly basis can end up taking a significant amount of time that might cost an entrepreneur more time than they are worth to have on their income statement. A great example of this, is if an entrepreneur purchases an office printer for three hundred dollars. It is technically an asset, but trying to figure out the depreciating value of that over years may not be worth the time it takes. If an entrepreneur has a couple dozen of these small assets, it may take them significant hours every year, which is most likely better spent in growing their business instead of figuring out the depreciation of small assets.
By understanding the common types of assets, outsourced CFO says entrepreneurs can start to understand the difference between assets and expenses. Vehicles are one of the most common types of assets. Contractors go through lots of trucks in their business so any types of vehicles are considered assets. Entrepreneurs should also understand that leaseholder improvements are also considered fixed assets. Because once an entrepreneur makes the purchase, it is going to help the entrepreneur do their business for a long period of time. For example, an entrepreneur that rewires the electric wiring in their office, puts a new roof on the building, or puts new siding up will be able to benefit from that leaseholder improvement for several years as they continue to have a place to operate their business.
Outsourced CFO | Assets Versus Expenses
If entrepreneurs are learning how to read to their interim financial statements but not learning how to classify assets and expenses, outsourced CFO says they may end up with unusable or incorrect interim financial statements. When they go to make financial decisions in their business, if the interim statements are not accurate, they may end up inadvertently making poor financial decisions in their business.
Entrepreneurs should understand how when they purchase assets are they going to appear on their interim financial statements. Outsourced CFO says contrary to what many entrepreneurs believe, when they purchase and assets, the expense should not show up on their income statements. Or at least, they are not going to show up right away. The asset is going to completely bypasses the income statement initially and bit put directly onto the balance sheet. However, once an entrepreneur makes the initial purchase, the asset will show up on the income statement as it depreciates. This should have been once a year this way, the entrepreneur will not have an extremely negative hit in the month that they made a significant asset purchase, however they will see the balance of the purchase come back onto the income statement slowly over time.
This ends up satisfying the revenue and expense matching principle. This principle means that the expenses are matched to the income that they generate. Which means that when an entrepreneur is looking at the income of a certain time period, It should match the expenses that happen in the same time period.
Outsourced CFO recommends that entrepreneurs set up separate subaccounts for significant fixed assets in an effort to stay organized and have the most information possible on these assets in preparation of those assets ever being resold, or if an entrepreneur is going to be selling their business. These subaccounts will help an entrepreneur keep the most information possible and is especially helpful when keeping track of assets that are most likely going to be resold such as vehicles. Computers are a great example of assets that are less likely to be resold at a significant value due to the tendency for them to become obsolete in a shorter period of time.
If entrepreneurs see small changes to the asset accounts, they should understand that not only is that a likely mistake, but outsourced CFO says that the likely mistake is an misclassification of an expense as an assets. Since entrepreneurs are only putting in assets that are over a thousand dollars into their fixed asset accounts, if it is under thousand dollars business owners should reclassify that as an expense instead.
By understanding how to classify expenses versus assets, entrepreneurs will ensure that there interim financial statements are kept as accurate as possible so that they can have the best information make financial decisions with in their business.