• September 2019
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Capitalization

Capitalization is not just what you do to the beginnings of sentences and proper names. Capitalization also refers to the sum of a company’s long term debt and retained earnings. It can also refer to the number of shares times the share price.

Capitalization actually has two meanings as it concerns you, the business owner, with one meaning for accounting and another for finance. On the accounting side of things, it’s an accounting rule used by capital-heavy businesses like construction companies with lots of expensive equipment that’s a large portion of their total expenses. On the finance end of the spectrum, capitalization is the quantitative assessment of a firm’s capital structure.

 

In accounting, the goal is to record your revenue and expenses as you incur them. An example of this is office supplies like paper clips and staples, which are expensed immediately because they are usually used immediately. However, other kinds of office expenses like computers and company cars won’t be expensed in a single accounting period because you probably don’t throw out a computer or a car after a single use. And if you do, that’s really weird and you should reconsider your life.

If it’s something like a computer or a car that you’ll use for a long period of time if you’re a normal person, then the costs are capitalized rather than expensed. Accountants are fans of capitalized assets because you don’t have to expense it all in one period but rather over 20 years if it’s a huge purchase. Because you are likely using the computer or car to generate revenue for your company, a portion of the cost of said equipment can be written off over a period of time, which is known as depreciation or amortization.

 

If the equipment you’re using is leased, which can happen a lot for startup companies who need expensive equipment and don’t have the money upfront to cover the whole cost, you can convert the operating lease into a capital lease by listing it as purchased asset  and recording it on the balance sheet as part of your assets. The value of the asset will be representative of either the market value or the current value of the lease payments, whichever is smaller. The amount you still owe on the lease is listed as a liability on your balance sheet.

 

EXAMPLE:

I’ve been using the same computer at my work for 10 years, so I’ve really maximized the capitalization benefits. But also I probably need a new computer because this one still can only do a dial up connection to the internet.