Financial education cannot be reserved for big business people. Anyone who participates in this world must have some basic notions on the subject to be able to make wiser decisions. A clear example is the difference between spending and investing. This cannot only be understood by managers at the head of an organization. Citizens who design their investment strategy must also have access to this knowledge.
Although they may at first appear similar, these two terms have very different meanings. Both, of course, involve an outlay of money. And the objective is identical: to acquire a good or contract any service.
But investment, also known as fixed assets, is not just about enjoying the good or service. Unlike expenditure, it aims to become a lever for the business, generating a future return.
Knowing which category each purchase made by the company falls into is essential. And not only for more efficient management of the business. It is also for tax purposes. Expenditure and investment are not deducted in the same way, and making a mistake during its declaration can lead to penalties by the Tax Agency.
So what is the difference between expenditure and investment?
The four main differences between expenditure and investment
The first difference between expenditure and investment lies in the period of usefulness of the asset acquired. It will be considered an investment if it is durable for the company and promotes the generation of regular income for some time longer than one year. The expense, on the other hand, only allows profits to be obtained during the fiscal year the purchase was made since its useful life is less than one year.
The acquisition of mobile telephones by an organization illustrates this situation perfectly. If you buy them, they become part of your assets. Their useful life is longer than one year, and employees will use them to work and earn income. They are, therefore, an investment. If, on the other hand, you rent them for a few months, you will have to pay for them again if you wish to continue using them after the end of the contract.
The second difference between expenditure and investment is related to the documents in which asset acquisition must be reflected. The investment is considered an asset since it is the company’s property and forms part of its goods and rights. For this reason, it has to appear in the balance sheet, the document that groups all the assets of a given company.
The expense is not an asset since it is part of the obligations to be assumed. Like the rest of the liabilities, it has to be shown in the income statement, a document where expenses are subtracted from revenues, to find the profit.
The third difference between expenditure and investment is whether or not there is a decrease in equity. Expenses directly affect equity, which is reduced. In the case of investment, there is no reduction as such but a variation in the composition of the assets.
If a construction company purchases machinery with cash, even though its liquidity decreases, its equity remains intact since the value of the assets is the same. However, if it rents it, once the contract expires, it will have neither the cash nor the machines, so its equity is lower.
To understand the fourth and last difference between expenditure and investment, it is necessary to consider the activity and the sector to which the company belongs. Depending on what it does, the same acquisition can be considered an expense or an investment. The cell phones in the first example are an investment in an office but an expense in an electronics store that sells them to consumers.
The difference between spending and investment at the fiscal level
There is also a big difference between expenditure and investment in the tax field. A difference essential to know perfectly to avoid incurring tax violations. The accounting of expenses and investments is not the same.
Expenses can be deductible in the fiscal year in which they are acquired. Likewise, investments of less than 300 euros can also be charged as an expense. But if the amount exceeds 300 euros, the Tax Authorities do not allow them to be deducted in full in a single period. Instead, these are charged as expenses over their useful life through depreciation, which considers aspects such as depreciation due to the use or obsolescence of the asset.
To guide companies in these calculations, the AEAT has published a table to guide them in the depreciation of their investments. Not all assets compute the same, but each has certain figures associated with it depending on its useful life.
However, there are not all differences between expenditure and investment. For example, the VAT of the operation is deducted in the quarter of acquisition in both cases, regardless of whether it is an expense or an investment.
This table drawn up by the Tax Agency offers organizations two possibilities. If they wish to extend the process as long as possible, they can amortize their investments over the maximum period of years. But another formula is more recommended for those who want to amortize their investments quickly. These firms will opt for the maximum linear coefficient, the highest percentage that can be deducted annually. The depreciation schedule is calculated at the beginning of the process and generally cannot be modified.
Suppose, for example; a construction company buys an excavator with a useful life of more than one year. Although its cash flow decreases, the machine becomes part of its assets. There is no loss, only a change in equity. In addition, the excavator will be key to future income generation. Therefore, it is an investment that must be reflected in the balance sheet.
How should the construction company proceed to depreciate it correctly? To begin with, he will deduct the VAT in the same quarter in which he acquires it. Next, the official AEAT information will be checked to see its depreciation possibilities.
According to the table, the machinery can be depreciated over a maximum period of 18 years or with a maximum linear coefficient of 12%. In this way, the construction company could deduct it as an expense for almost two decades or, if it opts for the second option, it will reduce the number of years to a little more than eight.
Whichever method is used, there will come a time when the excavator’s useful life ends, and the company will have to buy another one to continue in business and not hurt its bottom line. You can save the amount deducted yearly to avoid such a sudden outlay. This way, when it is time to buy it again, you will not be forced to borrow or resort to other sources to get the money you need.
This is cross-cutting knowledge applicable to all sectors of the economy. Whether you are an entrepreneur launching your business, a saver looking to finance invoices to multiply your capital, a manager at the head of a multinational or a sustainable project that resorts to alternative financing platforms. All of them must know the difference between expenditure and investment.