Capital assets are expensive items purchased to generate sales over a long period of time (longer than a year) and are not sold in the usual course of business. So, if you’re in the business of selling tractors, buying a tractor to sell, while expensive, isn’t a capital asset, it’s considered inventory. Capital assets are considered long-term assets on the balance sheet. All the other categories we talked about are considered current assets.
Because these items generate sales over a period longer than a year, their cost needs to spread out over that time. This is called depreciating a capital asset. You’ll see this expense on the income statement as depreciation expense or amortization expense. (While technically not the same thing, depreciation and amortization are normally used interchangeably). By spreading out the cost, you’re matching up revenue to the resources required to generate that revenue.
Get to the Point
Assets are a very important part of your business, without them you wouldn’t be able to carry on operations. The current assets (cash, accounts receivable, inventory, prepaid expenses, etc.) are assets that are fairly liquid and will be used up over the course of the year. These assets are useful in determining how agile your company is. If there was a big change in your environment, like a new law was passed that made operations difficult, or a new technology that disrupted your unique offer, would your company be able to adjust? If your money is tied up in assets that aren’t very liquid, like capital assets, the answer is probably not very quickly. Sometimes that’s just the nature of the industry. Companies that have capital intensive operations, like breweries or manufacturing companies, will have a lot of money in their long-term assets, but they require that structure to operate. Striking the balance will depend on the specifics of your company, but you can look at industry benchmarks to see what’s normal for your industry.
If you have questions about your specific situation, then let’s chat!