You check your profit and loss report. Looks solid. Then your bank account tells a different story. And when it’s time to apply for financing, sell the business, or file taxes, someone’s raising their eyebrow at your numbers.
That eyebrow? It’s pointed straight at prepaid expenses.
This is one of the most common accounting mistakes we see. It quietly throws off your margins, messes with your financial reports, and makes your business look less profitable than it really is.
The worst part? Most owners have no idea it’s happening.
So, What Are Prepaid Expenses?
Prepaid expenses (or ‘prepaids’ for short) are payments you make in advance for goods or services you’ll use later. Think annual insurance premiums, software subscriptions, marketing retainers, pre-paid rent, or bulk orders that won’t be used right away.
You’ve already paid the money, but you haven’t actually “used” the thing you paid for yet. So the value is still sitting there, waiting to be recognized month by month.
That’s where the mistake happens.
How Prepaids Blows Up Your Financials
Let’s say you land $30,000 in revenue this month. Great. But you also paid $9,600 for a 12-month insurance policy. If your books count that full $9,600 as a June expense, your profit margin tanks for no good reason.
What looks like a rough month was actually a solid one. You just recorded the expense all at once instead of spreading it out evenly across the year.
And that matters. Because when your margins look thin, lenders get nervous. So do potential investors, partners, and even the IRS if your income suddenly swings without a clear reason.
Here’s What that Red Flag Looks Like to Outsiders:
- Wild swings in profit margins from month to month
- High expenses with no matching revenue
- A business that looks unstable or poorly managed
- Books that don’t match your cash flow reality
This doesn’t just confuse you. It makes anyone reviewing your financials wonder if you know what you’re doing… or worse, if you’re hiding something.
The Right Way to Handle Prepaids
If you’re using accrual accounting (or want to start), prepaid expenses should show up as an asset on your balance sheet first. Then, each month, you expense just the portion you’ve actually used.
In our earlier example? That $9,600 should be expensed at $800 per month over 12 months. Not dumped into a single month’s P&L like a financial hand grenade.
It’s an easy fix with the right setup. Your accounting software can handle it, or we can show you how to track it without blowing up your books.
Clean Books = Trust, Financing and Peace of Mind
Whether you’re applying for a loan, preparing for tax season, or thinking about selling your business, accuracy matters. Prepaid expenses might seem small, but they can make a big difference in how your business looks to everyone who matters.
This isn’t about perfection. It’s about clarity.
If your profit margins look off, but your gut says otherwise, you’re probably right. Prepaid expenses could be throwing everything off. We’ll help you clean it up so lenders, partners and the IRS see the real story.
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