Prepaid Expenses

Definition

Prepaid expenses are payments made in advance for goods or services that will be received or used in the future. They are recorded as assets on the balance sheet and are classified as current assets.

Example

For example, a company may pay for a one-year subscription to a software service in advance. The company would record the payment as a prepaid expense on the balance sheet. The prepaid expense would be reported as an asset and the expense would be amortized over the duration of the software subscription.

Why it Matters

Prepaid expenses are important for businesses to track and manage because they can have a significant impact on the company's financial statements. Prepaid expenses are important to track so renewals and cashflow can be well forecasted.Finally, prepaid expenses can be used to take advantage of discounts. For example, if a company pays for a one-year subscription to a software service in advance, it may be able to take advantage of a discount that is offered for paying in advance. This can help to reduce the company's overall expenses, but at the expense of a higher initial cash outflow.