Ownership has its perks: your guide to understanding assets
I am 100% reliant on my computer to do ANYTHING in my business. More specifically, I have an old 2013 refurbished MacBook Pro that I have upgraded and rebuilt a few times already, in an attempt to keep this baby alive and functional. But if you’re reliant on any machine – computer or otherwise – to make your business sing, you know that gut-wrenching feeling of hearing the early signs of its demise. For me, it’s the computer fan CHUGGING audibly for hours on end, and the intense heat radiating onto my lap. And of course, the PAINFULLY delayed response time when I try to get work done – and no amount of CTRL-ALT-DELETE / restarting of my computer can fix the issues.
I’m getting ALL the warning signs. The past month I’ve been dreading the day that I turn on my computer, and it doesn’t actually turn on. It hasn’t happened yet, but my Spidey-Senses are ON FIRE!
One of these days I’ll be making the stressful trek down to the Apple Store to drop a gross amount of cash (ahem…credit) on a new computer. I’m not looking forward to it.
My imminent doom is now YOUR bonus, cause it’s a great excuse to talk about Assets. A few months back, I talked a bit about assets when we were diving into financial statements (go check out WTH is a Balance Sheet), but let’s go a little deeper.
What’s an Asset?
An asset is something you own in your business that has value. Think of your top-of-the-line camera if you're a photographer, or that fancy sewing machine if you're a designer. These aren't just cool toys; they're assets that help you make money!
There are two ways you can get an asset: Buy it or Earn it.
When you buy something, there’s a few questions that you can ask yourself to decide if it’s just a regular expense, or if it’s actually an asset:
1. Does it add value to your business?
Do you remember when we used to BUY software? Like the actual discs that you’d install on your computer? I used to have Adobe Suite (photoshop, illustrator, indesign) on disc. I bought it once, installed it on my computer and if I wanted updates, I’d have to register it. Back in the day, when we had that, we OWNED that software license and could use it as long as we wanted, and never have to pay for it again (unless we wanted to upgrade). Sounds magical right? This was an asset. Today, the world of owning software is pretty much gone. Companies will ONLY sell you a subscription to use their software. If you cancel your subscription, you can no longer use the software. Software subscriptions today, are no longer assets. They’re useful, yes, but they don’t increase the value of our companies, and the second we stop paying for it, they go away.
Another way to look at it is, if you were to sell your business, what would be part of the deal? That software that you OWN – that would be part of the deal; your subscriptions…not really cause they’re in your name; the new owners would likely need to set up their own accounts (or you’d need to transfer them somehow)
2. Can you use it over MANY years?
My laptop? That’s not a regular purchase. I’m buying a new laptop MAYBE once every 3-5 years – longer if I can keep upgrading it! Notepads? Yes you might use one for several months, but generally speaking those aren’t lasting you several years. If something is used/lost within a year, we can generally call that a simple “expense”; if we’re going to get several years of use out of an item, that’s when we want to consider it an asset.
3. Will it help you earn money in the future – but not right now?
While it might be a little gross on your bank account at the time, the truth of the matter is that buying supplies in bulk can get you a WAYYY better price. Unless you’re dealing with perishables (I’m talking to you my foodies out there!), when you bring in, say, boxes full of gems and stones, there’s no way you’re turning that into product immediately; and even less likely that you’re selling it right away. When this happens, those raw materials or unsold products are your ASSETS. They’re pieces that, in a pinch, you could sell and get some quick cash for your business. When they ACTUALLY sell, that’s when they become an expense – Cost of Goods Sold.
Types of Assets
Assets are grouped according to how quickly they can translate into cash. It’s good to have a blend of these so you can both ensure you can manage the day to day needs of your business, while also investing your money in ways that will help you grow overtime.
There are three main types of assets:
1. Cash – this is your actual money. Whether it’s in your pocket, under your mattress, or in your bank account, cash is you #1 accessible asset. This is what pays the bills and keeps the business-wheel moving.
2. Current Assets – these are things that can quickly be turned into cash. I like to think of these assets as ones that will convert to cash within a year. Here’s a few examples:
a. Accounts Receivable
b. Clearing Accounts/Undeposited Funds
c. Inventory
3. Long-Term Assets – these are Items that stick around for a while, like that laptop we mentioned. If current assets are used/sold within a year, long-term assets last LONGER than a year. These are things like:
a. Computers
b. Vehicles
c. Office Equipment
d. Manufacturing Equipment
e. Furniture & Fixtures
How Assets Become Expenses
Now, if assets get parked on a Balance Sheet, how can we get their tax benefits!?! Taxes are paid based on our NET INCOME (Revenues less expenses). When we buy assets, they don’t show up on this income statement so what good are they?!?
Don’t despair, the tax nerds have got you covered.
COST OF GOOD SOLD
The first way costs get from your balance sheet to your income statement is as Cost of Goods Sold (COGS). I mentioned this above, but COGS is all about inventory. If you have storage shelves FULL of product, those items on the shelf are INVENTORY (assets). When you take a box off that shelf and sell it at a market, store, or online, then it becomes an expense, or COGS.
For example, say you’ve got a bracelet that cost you $5 each to make, and you’ve got 100 of them on your shelf. You’d have $500 worth of inventory ($5 x 100).
You go to a market and sell 20 of those bracelets, so now you will have $100 as your COGS (20x $5 each), and your inventory would now be $400 ($500 - $100 = $400). That $100 is now on your income statement and will reduce your income --- and the taxes you will need to pay.
DEPRECIATION
The second way that assets help decrease your taxes is depreciation. Everyone knows the unfortunate truth, that as soon as you drive a new car off the dealership lot, it drops almost 50% in value. That’s depreciation. It’s stupid when it comes to vehicles, but a little more logical for everything else.
Depreciation is an accountant’s way of dividing the cost of your asset over its lifetime. This way you only expense one years’ value at a time.
Accountants have a little cheat sheet for what the normal “lifetime” of various assets are, but let’s take my computer as an example. A new computer is going to cost me about $4K (BARF!!). According to the accounting gods, a computer has a lifespan of about 3 years before it needs to be replaced – that sounds about right, though I definitely try to stretch that out with upgrades and repairs (I don’t like change – haha!).
So, if I buy a new laptop today, instead of having a 4K expense this year ONLY, I’m going to split that out over 3 years:
Year 1 = $1300
Year 2 = $1300
Year 3 = $1300
Year 4 = $100
It spreads that expense over several years, so I get the benefit of the expense as long as that asset has value.
In a Nutshell
Assets are the tools in your creative toolbox. They're valuable, come in different forms, and get a little beat up and tired over time (just like us!). Understanding assets helps you paint a clear financial picture of your business, and shows you the value you’ve built in your business.
So next time you splurge on a new machine or invest in a pallet of raw materials, remember – you're not just spending money; you're investing in assets that empower your creativity and fuel your business forward….in case you need a reason to justify your spending!