It is important to make the distinction between your company’s revenue and capital expenditure so that a true reflection of the company’s profitability can be correctly shown on its financial statements.
Because you are charged tax on your profits (and your profits are affected by revenue expenditure, not capital expenditure), we want to make sure you understand the difference as it applies to your business.
Capital expenditure is an amount spent to acquire or significantly improve the capacity or capability of a long term asset, such as equipment or property. Usually this cost is recorded in a balance sheet and the assets cost (except the cost of land) will then be allocated to depreciation expense over the useful life of the asset.
Revenue expenditure is a short term expense for purchases used in the current period or typically within one year. This type of expenditure is usually the operational costs of running a business such as wages, repair and maintenance costs and rent. Revenue costs are recorded on the profit and loss statement (otherwise known as the income statement).
Let’s look at an example.
The owner of a new business purchases a new premises for £300,000 and total sales in the first year are £100,000. Although the sales figures look good, the purchase of the property would lead to a substantial loss if it were to be included in the profit and loss calculation for year 1 (income minus expenses equals profit).
The following year’s sales are reported at £25,000. Although the sales are much lower, as the property was purchased the year before, the company makes a profit. By taking into account the purchase of the property in the first year, the profit and loss has not shown a true reflection of how the business is performing.
To avoid this scenario, the purchase of property should be classed as capital expenditure. This ensures that the property will not be shown in the calculation of the profit on the P&L statement, and the profit calculation will show more clearly how the business is performing.
What can and can’t be classed as capital expenditure has been largely debated over the years.
As a guide, the following are typical examples of capital expenditure:
- Buying any non-current asset (land, buildings, motor vehicles, machinery, computer equipment, office equipment.. To name a few)
- Expenditure bringing the new non-current asset into a state where it can be used by the business, such as installation costs and the correction of problems that existed before the purchase
- Delivery costs of non-current assets
- Improvements (but not repairs) of non-current assets
- Legal costs in buying land or property
As a general rule, any asset that will last for less than a year will be a revenue expense.
As a guide, the following are typical examples of revenue expenditure:
- Maintenance of non-current assets (such as fuel, road tax and vehicle insurance costs, servicing of vehicles and machines)
- The day to day running costs of a business (administration costs, wages, office supplies, distribution expenses)
It isn’t a case of one rule fits all…
What capital expenditure is to one company may not be capital expenditure to another.
If you sell vans as part of your trade then the purchase of vans is not capital expenditure, it is revenue income as it is the sales of goods or services sold as part of your trade. However for a builder who purchases a van to transport tools and materials, then the van will be a capital expenditure.
It is the nature of what it will be used for which is important rather than the nature of the goods themselves.
If you’re unsure about your own expenses…
Get in touch with us today to find out how Fresh Financials can help your business correctly record your business expenses.