What is Capitalize?
When an asset is expected to generate benefits over multiple periods, capitalization is used to reflect this. This accounting technique recognizes the cost of the asset as an investment rather than an immediate expense. Instead of impacting the current period's income statement, the cost is gradually expensed over the asset's functional life, appearing as a long-term investment on the balance sheet.
Capitalize Explained
In accounting, to capitalize means to record a cost as an asset on the balance sheet, instead of expensing it in the period it was incurred. This way, the asset can be depreciated or amortized over its useful life, matching the expense with the revenue it generates. Capitalizing an asset can reduce the volatility of the income statement, improve the financial ratios, and align the cash flows with the expenses.
In finance, capitalization refers to the total amount of a company’s equity, debt, and retained earnings, which represents its capital structure. Capitalization also means the process of converting an idea or a project into a profitable business or investment.
Benefits of Capitalize in Finance
-
Income Smoothing: When you capitalize expenses for long-term assets, like equipment, you spread their cost over their useful life. This smooths out your income statement, making your profits seem more consistent.
-
Improved Asset Valuation: Capitalizing expenses means your assets are valued more accurately, reflecting their long-term benefit to your business. This can be attractive to investors.
-
Increased Debt Capacity: Higher asset values can improve your debt-to-equity ratio, potentially giving you access to more borrowing power.