Prepaid Expenses

Definition

Prepaid expenses are upfront payments for goods or services that a business will use down the line. In accounting, these payments are initially marked as assets on the balance sheet because they represent future benefits. As time goes by and the business starts using what it paid for, the prepaid expense shifts over to the income statement, lining up the cost with the period when it’s actually being used.

Why it matters

Prepaid expenses keep financials in sync by matching costs with the periods they benefit. Say a business pays for a year’s insurance upfront; instead of recording the full amount as an expense right away, it’s spread out month by month. This gives an accurate financial picture, showing what’s been paid ahead versus what’s actually been used. 

Managing prepaid expenses smartly also smooths out cash flow planning and budgeting since it’s clear which expenses are covered, making financial reports more accurate and future planning easier.