All of us like to accumulate assets. This inherent nature exists amongst entrepreneurs as well. Hence it is not uncommon to see entrepreneurs and small business owners buy assets when they have money. But this kind of asset creation has not helped too many entrepreneurs and small business truly scale to their potential. Why do you think this happens?
First things First! Let us understand what ‘assets’ are, from an accounting perspective – they are objects that we purchase ownership to. Businesses attempt to own things – equipments, land, buildings, cars, etc.,. All of these appear on the ‘Asset’ side of the balance sheet. But on the asset side you also see such entries – cash, inventory, receivables, etc.,. While all of the above are what a company owns, they fall under two categories: short term assets and long term assets. The short term assets are also called ‘current assets’. These are assets which the business can realise value from in the near term (typically one accounting period, usually one year). For example: cash, receivables, etc.,. The long term assets are those that the business derives value from over a long period of time (multiple accounting periods, usually more than one year). For example: land, building, equipment, vehicles, etc.,.
Assets are created by enterprises by incurring expenses. But these expenses are not fully chargeable to the Profit/Loss Statement (https://rajshankar.wordpress.com/2013/11/01/finance-for-entrepreneurs-what-is-a-profit-loss-statement/ ) in the same period in which the expense is actually dispensed with. The reason for this is that, to ensure fair accounting practice. Hence it is only good to spread the cost of the asset over the period through which it provides value to the company. Lets take an example: An equipment costs the company 10 lakhs. The estimated life of the equipment is say 10 years. If that be the case, the enterprise will derive value from the equipment for 10 years, utilise the equipment to produce for 10 years. In this case, how is it fair to charge the entire 10 lakhs to the Profit/Loss statement in the year in which it was incurred. One it doesn’t seem fair because the equipment is contributing to the revenue over the ten years and second, if charged in one year will make that year’s performance look poor. This will also lead to avoidance of taxes as every year the enterprise can simply keep purchasing assets to show expenses!
Hence it has been agreed that the cost of the asset will be charged over the life time of the asset. This yearly charge is called depreciation, a non-cash expense. Only the charge that is applicable for this year is taken to the Profit/Loss Statement as expense (Depreciation). It is called ‘non-cash’ expense simply because it is not actually spent in the year in which it is charged.
What kind of assets should start-ups try to create? This requires some thinking. But a couple of simple rules can help: Create assets that can help the enterprise generate revenue in the future. Create assets only when they cannot be borrowed, begged for, or stolen. (https://rajshankar.wordpress.com/2014/05/13/entrepreneurial-skills-beg-borrow-steal/ ) Now this varies from business to business. In case of a IT Services enterprises, it could be intellectual property, or people, R&D, Organisational knowledge, etc. In the case of a clothing company, it could be machines, factory space, etc.,.
Well thought of investments into assets can help a company grow fast. If investments are not prudent, businesses will end up with assets which may become valuable but will not enrich the future revenue generation capacity of the enterprise. Example: A small IT firm invests in a large land and building. While the property will appreciate in value, it does not necessarily translate into future revenue from software services!
Think about it!