Fixed Assets - Yes They Are Manageable
Whenever the topic of Fixed Assets comes up many of us cringe anticipating a highly technical and difficult process.
In reality, Fixed Assets (or Property, Plant, & Equipment) for the majority of small businesses can be relatively straightforward.
What is a Fixed Asset?
A Fixed Asset is an item that you can expect to have long-term (more than 1 year) and that is used in the operation of the business to generate income.
For example, a truck purchased to make deliveries is a Fixed Asset since it is expected to be
Long-term -> you can expect a vehicle to last several years
Used in operation to generate income -> used for deliveries to customers
Think of a Fixed Asset as something you must have for your business to run that is costly to purchase, is expected to be used for several years, and is not easily sold or removed.
Why bother using Fixed Assets?
In simplified terms think of Fixed Assets as a way to show an increase in the value of your company and to spread out the cost of a large purchase over time.
Imagine you bought a machine that cost $1 Million to purchase and is expected to last 20 years.
First, you would want to show that the value of your company has increased, since if you sold the entire business this machine would be a part of that sale and so should be reflected in what the business is actually worth.
Second, in regards to the actual expense of the item, you would not want the full cost to show up all at once.
Having a $1M expense would significantly impact your P&L for that year and following years would not reflect the cost as the machine is used over its lifetime.
Basically, imagine that instead of purchasing one $1M machine that will last 20 years, you had to buy a $50,000 machine each year for 20 years.
Fixed Asset Depreciation allows you to spread out the expense over the life of the asset, while also decreasing the asset’s value on the Balance Sheet allowing for decreases to its Fair Market Value. (A used machine is not as valuable as a new one typically).
Isn’t figuring out Depreciation really hard?
No, it does not have to be.
While there are various methods of depreciation, some more complicated than others, the easiest and best to use for most small businesses is the Straight-Line Method.
This method basically takes the Cost of the asset divided by it’s expected life.
Cost - Salvage
------------------ = Yearly Depreciation
For the majority of the time your Salvage value will be 0, unless you have a known amount it will be worth at the end of its life, if you are unsure talk to your accountant or CPA.
What is included in the “Cost” of an asset?
The “Cost” of an asset includes the cost to acquire and put the asset in use.
This means beyond the price of the asset itself, sales tax, shipping, professional fees (architect, inspector), import duties, installation, as well as, any rebates or discounts received.