Capitalize: Meaning & Definition

KEY TAKEAWAYS

• Capitalization is when you include expenses on your balance sheet.
• Capitalizing expenses helps improve your cash flow management and increases profitability.
• Capitalization works on PP&E, advertising expenses, and intangible assets.

What Is Capitalize?

Capitalize refers to the act of recording cost or expenses on a balance sheet. This is to spread the cost over the life of an asset, rather than expensing it all at once. By capitalizing an expense, a company can better manage its cash flow. And it can make more informed decisions about how to allocate its resources.

A balance sheet reports shareholders’ equity in a company, as well as liabilities and assets in a specific period.

The main purpose of a balance sheet is to give stakeholders a clue of the company’s financial health. The balance sheet can also assess whether a company has the resources to pay its debts when they come due.

The balance sheet is one of three important financial statements. Along with the income statement and cash flow statement. Together, these three statements give investors a clear picture of a company’s financial position.

The balance sheet is in two sections: the asset side and the liability side. The asset side lists all of the resources that a company owns, while the liability side lists all of the claims against those assets.

There are several list of characters that you can capitalize on a balance sheet, such as:

• Property, plant, and equipment (PP&E)
• Intangible assets
• Research and development costs
• Advertising expenses

The decision of whether or not to capitalize an expense is often made by accounting departments on a case-by-case basis. There are generally two schools of thought when it comes to capitalization:

1. Capitalize all expenses that will generate future revenue.
2. Only capitalize expenses that have a long-term benefit.

The first approach is more aggressive and may result in a higher level of debt on the balance sheet. The second approach is more conservative and may result in lower profits in the short-term. Ultimately, the decision of how to treat an expense should consider the company’s overall financial strategy.

Benefits of Capitalization

There are several benefits you can achieve by capitalizing expenses on a balance sheet. These benefits include:

1. Improved cash flow management: By capitalizing an expense, a company can better manage its cash flow by spreading the cost out over time. This allows the company to avoid taking on too much debt at once and can help to keep operating costs down.

2. More informed decision-making: Capitalization provides a company with more information about its expenses. And how they impact its financial position. This information can make more informed decisions about where to allocate resources.

3. Tax advantages: In some cases, capitalizing an expense may result in tax advantages. This is because the expense can be deducted over time, rather than all at once.

4. Increased profitability: Capitalizing expenses can often lead to increased profitability. This is because the expense spreads out over time, rather than expensed all at once.

Limitations of Capitalization

There are some potential drawbacks to capitalizing expenses on a balance sheet. These drawbacks include:

1. Higher level of debt: When an expense gets capitalized, it’s added to the company’s debt burden. This can increase the amount of interest that the company must pay and may result in higher levels of financial risk.

2. Lower short-term profits: Capitalizing an expense will often result in lower short-term profits. This is because the expense is not expensed until the asset is sold or disposed of.

3. Complexity: The capitalization process can be complex and may require special accounting knowledge. This complexity can make it difficult for small businesses to properly capitalize their expenses.

What Type of Assets are Capitalized?

There are several types of assets you can capitalize on a balance sheet. These assets include:

1. Property, plant, and equipment (PP&E): PP&E are long-term assets that are in the operation of a business. They include buildings, machinery, vehicles, and other equipment.

2. Intangible assets: Intangible assets are non-physical assets that have a value to the company. They include patents, copyrights, and trademarks.

3. Research and development costs: R&D costs are expenses incurred by a company in the process of developing new products or services.

4. Advertising expenses: These expenses are costs incurred by a company to promote its products or services.

5. Pre-production costs: These are expenses incurred by a company in the process of setting up production for a new product or service.

Summary

Capitalization is the process of including an expense on a balance sheet. Better cash flow and increased profitability are some of the benefits of capitalization.

You can capitalize several types of assets, including PP&E, intangible assets, and advertising expenses. Be sure to weigh the pros and cons of capitalization before making any decisions.