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Managing a Business’ Fixed Assets
This is one of the business terms that ‘non accountants’ try to avoid, or even overlook completely. I am simplifying it for you. It is actually quite straightforward; it just takes some commitment and understanding. Enjoy the learning experience.
What are Assets?
It is very important to understand this. Everything your business has or owns is an asset. All of it, bar none. Let’s go a bit deeper into this; consider the following.
Bank accounts balances (when positive) are current assets
Petty Cash Accounts balances are always current assets
Long term investments owned by the business are fixed assets
Raw materials on hand are current assets
Work in progress stock is a current asset
Stock on hand is a current asset
Stationery on hand is a current asset
Cleaning materials on hand is a current asset
Total Debtor’s balance is a current asset
Motor vehicles are fixed assets
Machinery is a fixed asset
Land and buildings owned by the business are fixed assets
Computer equipment is a fixed asset
Furniture and fittings are fixed assets
What are Fixed Assets?
In accounting terms there are generally two types of assets; Fixed Assets and Current Assets. The only difference between them is that current assets have a short life span, less than a year; while fixed assets have a longer life span; normally two years and longer. These two types of assets are also treated separately on the balance sheet. That’s it, very simple. Not so?
For example, the business’s Petty Cash Book (account) is a current asset. Why? Because the value changes daily, it is not stagnant or fixed. And it is very small in comparison to fixed assets such as buildings, land, machinery, etc. Compare it also to a fixed investment, which is usually long term in nature.
Toilet paper, stationery, stock, raw materials, cleaning materials, staff refreshments, and the like, are not going to exist for very long. No longer that about one month before you have used them up, and they need to replaced. However, land & buildings, vehicles, furniture, machinery, computers and office equipment you will have for at least three years before replacing them; if not much longer. The latter are Fixed Assets.
Another type of fixed asset of note is an intangible asset; an item or asset that you cannot touch or see. Above we spoke only of tangible assets, things that do physically exist. Intangible assets are:
Fixed Assets Categories
Land and buildings
Machinery and special tools
These are the more general fixed assets. For a detailed list, consult the Internationally Accepted Accounting Practice document or your local Revenue Service’s stipulated list of recognized fixed assets.
FIXED ASSETS REGISTER
It is vitally important that you keep record of your Fixed Assets in a Fixed Assets Register, either on a spreadsheet or in a physical book. One can also use a database program, which automates the procedure and is usually accurate. You can browse for these on the Internet and at your local computer shops.
Your accountant will also have a fixed asset register which will need to be updated each year for the audit and/or presentation of the annual financial statements. Always compare yours with his, make sure they are up to date and correlate 100%.
The added benefit is that you will be keeping a check on your accountant/auditor.
Is an asset a luxury?
This is a question that must regularly be faced by directors of businesses. Luxuries cause negative effects on one’s cash flow and profits and should be avoided.
For example, a company car needs to be purchased. What size and price group is most suitable? Is it to impress fellow business owners? Is it to make the person feel important? To what extent will it be for the person’s personal use? Can we actually afford it? Think carefully; don’t overspend and then wonder why you have a cash flow problem.
It is amazing how often a huge sum is paid for an asset, whilst there are more affordable options available. Often, machinery is purchased which is way over-productive. Its capacity is way above what is actually needed. The mindset is often, “well, let’s rather spend $250,000 and “over purchase”, rather than be stuck with something which may become too small and only costs $150,000″.
This is a valid argument but it can lead to a huge mistake.
Always go back to your original business plan. Consider the planned production and the sales plan, and then act accordingly; or revise the business plan. The worst thing would be to produce 5,000 products per month whilst there is only a monthly need of 2,000 (estimated capacity) in the market for the next eight years. You’d be stuck with 3,000 products per month, accumulating onward, and paying storage for them; because they are going nowhere. FATAL ERROR.
Do you see how important your business plan is? And that it needs constant revision and review? Treat it as a dynamic living document; your business bible.
When considering the purchase of a fixed asset:
Start with the Minimum Requirement when considering a new/replaced fixed asset
When considering the purchase of an asset, always first think of the minimum requirement and build from there. There are many factors to be taken into account; here are a few:
– Have you exhausted the supplier list?
– Have you used all resources to source this information?
– Have you considered all variables, e.g. size, capacity, life expectancy, price, usability?
– Have you researched past history of the models you are considering purchasing?
– Have you analyzed the reliability, maintenance and service requirements?
– To what extent does the purchase of the asset impact your cash flow? Do you have enough cash? Do you need to take a long-term loan, or buy the asset on a hire purchase agreement? Would it require a greater capital investment from the directors/owners in order to procure it?
– Can you actually afford it, or is there a cheaper solution or alternative?
Mistakes made in this regard are unnecessary. It’s much better to spend the time needed, and take every precaution to ensure you make a sound decision.
Insure all assets
This is vitally important. Make sure that your assets are insured at their correct values; thus ensuring that they are not over or under insured. This will cost you more money in the long run.
Over insured means wasting money monthly on a high premium and receiving much less if a claim is submitted. Under insuring means paying a lower premium monthly but receiving almost nothing if a claim is submitted.
Always make sure that your insurance details are up to date, correct and checked by the insurers.
Depreciation, Revaluation and Write Off of Fixed Assets
Depreciation always takes place annually. For management reports and for good corporate practice, it’s better to do it monthly. This also facilitates more accurate monthly business operating reports.
Remember, you don’t want to leave out any hidden costs, like depreciation, from your operating reports.
Depreciation can be calculated using two standard methods; The Straight Line method or The Decreasing Balance method.
The Straight Line Method
Facts and figures needed:
The life expectancy of the asset (e.g. vehicles are normally 5 years)
Purchase price (or realistic value) PLUS any additional costs (e.g. delivery cost & set up cost)
– Calculation example:
Vehicle cost $60,000. Depreciable over 5 years (60 months)
60,000 divided by 5 = $12,000 per year or $1,000 per month
The Decreasing Balance Method:
This method is done by using the same information as above, except that the depreciation percentage is always calculated on the decreased value.
Because a vehicle can be depreciated over five years, the percentage per year is then 20%.
First year: 60,000 X 20% = $12,000 (same as above)
Second year: 48,000 X 20% = $ 9,600 (much less)
And so on.
The problem with this method is that the depreciated value never reaches zero. It is complex, and the straight-line method always works best for me. I suggest you use it too.
Revaluation of Fixed Assets
Revaluations can be tricky, and should be avoided whenever possible. The only times where a revaluation of a fixed asset is valid are in two instances:
1. The asset was brought into the books at the incorrect value.
2. The market value of the asset fluctuates and the new market value is truly and remarkably different to the original purchase price plus related costs..
This article is written for business owners and managers. If you experience such an occurrence, speak to your accountant to recalculate the value and depreciation, as this is a tricky accounting procedure. Remember there will also be a loss or profit on revaluation, which must be reflected, in your financial statements.
Writing off Fixed Assets
This occurs when an asset is stolen, destroyed, or it has become totally irreparable at a decent cost. This is another instance, which will require your accountant’s attention. There are usually losses on write off of fixed assets, unless the asset is so old that it has no current value. This requires special accounting attention.
Should you dispose of a fixed asset, remember there will be a profit or loss on disposal and this needs to be reflected in financial statements. Speak to your accountant about it, as it requires special accounting attention.
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