“Should I Capitalize or
Expense IT Equipment?”
What’s Right For Your Business?
Every day, business owners must decide how to properly allocate their money. Should it be in equipment, people or advertising? A very common topic is the battle between capital expenditures and purchased items as services, which are a direct operating expense.
The term capital expenditure has to do with the purchase of equipment typically greater than $1000. When a business purchases equipment greater than $1000, the IRS instructs them to depreciate these products based on their useful life. Sometimes the product has a shorter life span than the projection, other times you get a longer life span, but it’s really a guessing game. In general, most business owners don’t like to gamble with their money and potential tax situations that come along with that.
A direct operating expense is just like any other expense – it gets written off when the check gets written, in that current month and during that current year.
Whether you should capitalize or expense IT equipment depends on a few factors, including your long-term business goals, accounting, and the equipment in question. While capitalizing equipment frees up cash flow since the costs aren’t expensed in the period they were incurred, it can also lead to potential drops in free cash flow and misleading profit margins. So the answer really does depend on your specific needs.
The question then becomes “Should I move my business into the cloud or continue to buy hardware?”
Moving Business IT Into Cloud vs. Buying Hardware
Buying Hardware
Hardware requires a business to invest in redundant power, the Internet, multiple circuits, security and ongoing maintenance. These purchases, plus the upfront cost of getting this into production, are all upfront costs to your business. Take into consideration that the average life span of a server today is 5 years, if the server is properly maintained.
When sizing a server for purchase, you always want to budget hardware 15-20% greater than your current needs to account for business growth. You must also account for adequate licensing to handle this potential growth.
Moving Your Business Into the Cloud
When you move your business into the cloud, an IT firm will size the environment for exactly what you need at that particular time. If your business grows, then you can ask to increase the specifications of the equipment you need. If your business starts to decline, an IT company can reduce the specifications down to the level that you need.
The process of moving everything into the cloud works with licensing as well. A business technically never owns licenses; they are basically rented from a service provider. Each month the business only gets billed for what they use.
Another benefit of cloud services is that your information is stored in high level data centers where internet and power redundancy are not an issue. Your data is always accessible from anywhere and protected from power and internet outages, as data centers rarely go down. The cloud provider takes care of security, up-time etc. for you so the ongoing maintenance factor is removed.
Once You've Purchased Hardware, What Happens if Your Business Declines?
You own licenses and equipment that are currently depreciating, but you’re not gaining the benefit from them anymore. This is the one of the negatives to buying hardware. You are depreciating equipment and software that you are not even using, and might not ever use again. This process repeats every 5 or so years, which makes buying hardware a job that requires constant upkeep.
Which is right for you?
It depends on your personal preference. Do you like to own things, or are you okay with renting them?
This question will continue to drive business owners crazy. A 5-7 year ROI cloud is typically more expensive than having an on-premise solution, but you have to consider the growth or decline potential of your business. The cloud gives you flexibility as you need it, while buying hardware is gambling on your situation and spending money on something you might never need to use.