Investopedia

Fact checked by Timothy Li
Reviewed by Michael J Boyle

Historically, countries have used tariffs to protect domestic products from foreign competition. While many countries have reduced tariffs through trade agreements, that trend is being undone fast, given the broad tariff regime announced by U.S. President Trump in 2025.

The Trump tariffs are the most sweeping in the U.S. since before World War I, ending what had been a long liberalization of trade barriers through decades of international agreements and the build-up of institutions meant to increase trade worldwide. The tariffs, including a baseline 10% on nearly all U.S. imports and additional tariffs the administration is dubbing “reciprocal” for many specific countries, are far higher for nations that have long been competitors of the U.S., and many that until 2025 weren’t. Vietnam (56%), Cambodia (59%), and Sri Lanka (54%) were among the hardest hit, but, so, too, were some of the world’s most valuable trade partnerships: tariffs were increased significantly on goods from China (44%), the EU (30%), and Japan (34%).

Key Takeaways

• Tariffs are taxes on imports imposed by a government to help direct domestic consumers toward goods made within the country.
• Less industrialized countries, such as those in Africa and the Caribbean, traditionally have had the highest tariff rates.
• In April 2025, the U.S. introduced significant new tariffs that put tariff rates well above historic rates. They are, for now, the world’s highest.
• Many economists view tariffs as liable to increase consumer prices and lead to higher inflation.
• Tariffs are not the only trade barrier: others include exchange controls, subsidies, fair trade laws, local-content requirements, and quotas on imports and exports.

While slapped on goods from specific countries, tariffs are taxes paid by consumers within the country that applies them. Those who support them argue they redirect domestic consumer demand toward goods made within the country. The 2025 Trump administration tariffs far outstrip previous highs worldwide for a country’s average tariff rate, according to data from the World Trade Organization. In 2024, those at the high end of the list included Algeria (18.9%), Cameroon (18.1%), and Tunisia (19.5%). Below, we review these figures further and explore their economic implications.

World’s Highest Tariffs

The landscape of global tariffs shifted dramatically following the U.S. administration’s April 2025 tariff rollout. Those tariffs include a baseline 10% on virtually all imports, with additional tariffs (the Trump administration labels them “reciprocal”) depending on the country. Below are the combined figures, which stand as the world’s highest as of April 2025.

These rates represent a consequential shift from historical patterns. While traditionally less-developed African and Caribbean countries maintained the highest tariffs, the U.S.’s moves are likely the beginning of a worldwide ratcheting up of tariffs on U.S. goods in response. The administration imposed particularly high tariffs on goods from many Southeast Asian manufacturing hubs. Major longstanding trading partners had substantial increases in duties placed on their goods, including China (44%), the European Union (30%), and Japan (34%).

Economists and international organizations have expressed concern about these dramatic increases, with the World Trade Organization warning they could cause global trade volumes to contract by 1% in 2025. “No one wins a trade war,” Justin Wolfers, professor of public policy and economics at the University of Michigan, told Investopedia, noting that economists are “very” concerned about a recession coming out of the significant increases in duties.

Warning

In the map below, we use a weighted average of tariffs calculated by the World Trade Organization for each country. However, countries often impose tariffs on specific goods that can be far higher than the average. For example, India has a 70% tariff on imported passenger vehicles, and many nations, including the U.S., had, before 2025, carved out specific areas of their economies to protect via import duties.

Lowest Tariffs

In contrast to the countries with high tariff rates, some nations have maintained very low or even zero tariffs. Despite the threats in recent years of protectionism led by the U.S., these countries had continued, at least until 2024, to maintain open trade policies. On the map below, those with the lowest or no tariffs in 2024 are in blue. They include Hong Kong, Singapore, Georgia, and Australia.

Tariffs vs. Free Trade

When Adam Smith published “The Wealth of Nations” in 1776, international trade was primarily defined by extremely restrictive import tariffs and quotas. Following Smith, David Ricardo in early 19th-century works developed the case for free trade in the early 19th century through his theory of comparative advantage.

Ricardo argued that countries benefit from specializing in producing goods where they have a relative efficiency advantage and trading for other goods, even if one country is more efficient at producing everything. Suppose you’re the manager of a baseball team. You could have Shohei Ohtani pitch and hit—he’s an elite talent at both—but you might produce more wins by having him focus on being a position player to maximize his effectiveness and prevent injury. You certainly, too, wouldn’t have Ohtani handing out water to other players when not up at bat or mowing the grass. That’s why economists argue that nations should specialize in areas where they have comparative advantages and freely trade with others for the rest (get someone else to handle the other role on the team). This way, total economic output increases, with each participating country benefiting over time. For this reason, economists have long argued for bringing down trade barriers—you want to make it easier for your country to get the goods that aren’t to its advantage to make.

Note

The average tariff rate for the U.S. in 2024 was 0.9% and was estimated to increase to between 22.5% and 24% from the April 2025 changes made by the Trump administration.

Ricardo’s ideas formed the foundation of modern trade theory and contributed to the consensus among economists that lowering trade barriers encourages economic growth—a view particularly strong among European and American economists in the second half of the 20th century, leading to a general decline in tariffs worldwide.

What Happens When There Are High Tariffs on Imported Goods?

High tariffs on imported goods increase the prices of these goods. As a result, consumers end up paying higher prices for the goods. Alternatively, consumers can opt to purchase substitute goods that are domestically made, which are most likely to be cheaper.

Do Any Countries Have No Tariffs?

Yes, a few countries do not have any tariffs, and several have very low tariffs. The World Bank reports tariffs on a weighted mean. Hong Kong (China), Macau (China), and Sudan have no tariffs.

Which Country Has the Highest Import Duty?

As of April 2025, that would be the U.S., with tariffs well above historic highs in recent decades.

The Bottom Line

Until 2025, many countries had abolished tariffs or lowered them significantly after signing free trade agreements to pursue foreign markets for their goods. Changes begun by the U.S. are likely to spark rounds of negotiations and reciprocal tariffs implemented by trading partners to match the Trump administration’s moves.

Fact checked by Suzanne Kvilhaug
Reviewed by Margaret James

If your business is new, there are several factors to consider before developing a sense of your ideal profit margin. In this article, we look at some of the basics of what you should consider when you’re measuring profitability and studying your profit margins.

Key Takeaways

• Profit margins are financial metrics that are used to measure a company’s profitability.
• A gross profit margin can be used to determine a particular item’s profitability, but net profit margins are a better measure of overall profitability.
• The net profit margin is key as it measures total sales, less any business expenses, and then divides that number by total revenue.
• The best net profit margin for your business depends on what industry your business is in, which means you shouldn’t compare your margins to companies in other industries.
• Newer companies may have better profit margins than older ones because when sales increase, so do manufacturing costs.

What Is a Profit Margin?

The profit margin is the total percentage of sales that results in profit. You have to subtract all of the expenses that go into running the business in order to get the resulting profit. A company’s profit margin tells interested parties (e.g. investors, creditors, and others) how well it handles its money.

There are several types of profit margins. We’ll look at two of the most common: the net profit margin and the gross profit margin.

Net Profit Margin

A company’s net profit margin, or net margin, measures profit (or net income) as a total percentage of revenue.

It’s typically expressed as a percentage, but in some cases, you may see it reported as a decimal.

Here’s how you figure out the net margin for a business. Take the company’s total sales and subtract the total business expenses incurred. Divide the result by the company’s total revenue. So if your new business brought in $300,000 last year and had expenses of $250,000, your net profit margin is 17%.

Net margins allow companies (and others) to see how well their business models are working and to measure their overall profitability. They are also used to help devise profit forecasts, which is especially useful for individuals who invest in public companies.

Gross Profit Margin

The gross profit margin, or the gross margin, is calculated by subtracting the cost of goods sold (COGS) from a company’s net sales. The result is then divided by its net sales.

It’s usually expressed as a percentage.

Major shifts in the gross margin may indicate that the company needs to make changes to the way it’s being managed. Or it may signal that the company’s products and services may need to be reviewed.

Small business owners use the gross profit margin to measure the profitability of a single product. If you sell a product for $50 and it costs you $35 to make, your gross profit margin is 30% ($15 divided by $50).

Note

Operating profit margin is the amount of profit a company makes per dollar after factoring in certain variable costs, such as labor and materials. But this metric doesn’t factor in taxes or interest. To calculate it, you divide the total operating income by the company’s net sales.

The Industry Makes a Difference

Profit margins are very dependent on the industry that a business operates in. Business owners make a higher margin in some sectors compared to others because of the economic factors of each industry. That’s why it’s important to keep the industry in mind (in addition to the business size) when you’re comparing the profit margins of any company with others. You have to make sure that you’re making an apples-to-apples comparison.

Let’s say you own a bakery. You kept really good records and, after doing the math, came up with a net profit margin of 21%. But your friend owns an IT company that installs complicated computer networks for businesses and has a net profit margin of 16%. Does this mean you’re a better business owner because your profit margin is five percentage points better? No. It doesn’t work that way, as the profit margin is industry-specific.

Similarly, you may expect margins of 19.8% as an accountant. If you’re in the food service business, you might only see net margins of 3.8%. Does this mean you should sell your bakery and become an accountant? No. Profit margin doesn’t measure how much money you will make or could make, only how much is actually made on each dollar of sales.

If you’re a consultant, your margins are likely quite high since you have very little overhead. You can’t compare yourself to a manufacturer who rents space and equipment and who must invest in raw materials.

Profit Margins of New vs. Established Companies

Many new business owners generally expect a lower profit margin in the early years of their operations. It’s not that they want to rake in lower profits. Rather, they believe that it takes time, effort, and a lot of money to start a business so making a profit may take some time.

In some cases, there’s an inverse relationship between profit margins and sales. For instance, profit margins in the service and manufacturing industries decrease as sales increase. Businesses in these sectors may see a 40% margin until they hit around $300,000 in annual sales. That’s about when the business has to start hiring more people. Each employee in a small business drives the margins lower.

Explain Like I’m Five

It’s hard to say what a good profit margin is, because it depends on your business and your industry. Some types of businesses, like software companies, will naturally have a higher profit margin than others, like restaurants. That’s because some businesses (like restaurants) have to spend more money to make money than other businesses (like software companies) do. This means you should only compare your business to businesses like it. So if you own a restaurant, don’t compare your profit margin to a software company. Compare it to other restaurants.

What Is a Good Gross Profit Margin Ratio?

A company’s gross profit margin ratio compares the company’s gross profit margin to its total revenue. It is expressed as a percentage. So if the ratio is 25%, that means that the company’s gross profit margin is 25 cents for every dollar in sales.

A higher gross profit margin ratio generally means that the business manages its sales costs well. But there’s no good way to determine what constitutes a good gross profit margin ratio. That’s because some sectors tend to have higher ratios than others. It’s not a one-size-fits-all approach.

What Are Good Gross Profit Margins for Various Major Industries?

NYU’s Stern Business School releases sector-related data on a regular basis. According to the school’s margin report from January 2025, the average gross profit margin for education companies was 41.15%. Machinery companies saw gross margins of 37.08%, while real estate developers saw margins of 35.13%. Oilfield services and equipment companies saw gross margins of 10.71%, and grocery stores raked in gross margins of 26.09%. Software had some of the highest margins.

What Is a Good Profit Margin for a Small Business?

The profit margin for small businesses depend on the size and nature of the business. Keep in mind, though, that certain businesses may see lower margins, such as retail or food-related companies. That’s because they tend to have higher overhead costs.

The Bottom Line

In the beginning, when your company is small and simple, margins could be quite high. You don’t have a large workforce and other substantial overhead expenses. As your sales increase and your business grows, more money comes in. But your margins will likely shrink because you’re probably hiring more people, investing in bigger facilities, and expanding your product line. Simply bringing in more cash doesn’t mean you’re making a bigger profit.

Remember, as your business expands, tend to its margins. Larger sales figures are great, but make sure you’re earning maximum money on those sales.

Reviewed by Erika Rasure
Fact checked by Betsy Petrick

Target Corporation’s RedCard program is a leading loyalty program among retailers in the United States. The program is accessible to everyone and is integrated seamlessly into customers’ payment methods.

With lower barriers to entry than other loyalty programs, Target tries to build a relationship with its customers and can personalize the promotions and advertising offered to the consumer with this card.

Target’s RedCard comes in three forms: a Mastercard (open loop card), an in-store-only credit card, or a debit card. The debit card is linked to customers’ existing checking accounts, and for the in-store card, users can charge in-store purchases or buy online with the credit card at Target.com.

The Target-branded Mastercard can be used anywhere that accepts Mastercard. In this article, we are primarily discussing the Target RedCard debit card and in-store credit card, not the Mastercard.

Key Takeaways

• All Target cards can be used at Target stores (brick-and-mortar and online).
• The Target RedCard comes with 5% off purchases and free two-day shipping.
• The Target debit card is linked to your checking account.
• If you regularly shop at Target, the perks of a RedCard may be worth the high rates.

Features of the Target RedCard

All Target cards offer 5% off purchases every day at in-store and online locations and free two-day shipping on most items. Users also have an extended return facility giving them 30 extra days to return products to Target or Target.com. However, RedCard extended returns do not apply to the following:

• Target Optical purchases
• Non-returnable items
• Contract mobile phones
• Online purchases of Supplemental Nutrition Assistance Program (SNAP) eligible
  items using both Electronic Benefits Transfer (EBT) and a RedCard for
  payment.

The Target RedCard has a late payment fee of up to $41 and a return payment fee of up to $30. Customers looking to combine the benefits of the RedCard with a more traditional credit card can sign up for a Mastercard Incorporated RedCard through TD Bank, USA.

What’s in It for Target?

Most companies use loyalty programs to collect customer data in addition to building loyalty among patrons. Target’s data collection system is thorough.

Every purchase, email, or phone call is tracked, and data is applied to algorithms for marketing and planning purposes. By collecting data, the company can personalize deals and discounts for its shoppers.

Important

You should pay off your credit card balance every month to avoid high interest charges.

How Can I Get a Target RedCard?

You can get a Target RedCard by applying online for one. The RedCard credit application is on the Target.com website. You must verify your employment and income and review the terms.

You may be approved to shop online instantly, or you may have to wait for seven to 10 days to get your card, depending on whether Target approves you automatically.

The website isn’t 100% clear on how long it may take to be approved for either RedCard if you are not automatically approved. If you are not approved it may be due to red flags on your credit report or a low credit score.

Like any credit card, you have to meet certain requirements to be approved for a new credit card. If you apply and are not instantly approved, you may get a notice that your file is “in review.”

Is the Target RedCard a Credit Card?

Yes. Target offers a RedCard credit card issued by TD Bank USA. The RedCard brand also has two other options: an in-store credit card and a debit card.

Where Can I Use My Target RedCard?

You can use a Target RedCard Mastercard credit card anywhere that takes Mastercard, and you can use your Target RedCard charge card or Target debit card at Target stores or on Target.com.

How Do I Pay My Target RedCard?

You can pay your Target RedCard charge card online. In the case of the Target RedCard debit card, the money comes immediately out of your checking account when you use it.

How Long Does It Take for the Target RedCard to Post to My Account?

Your Target RedCard may be added immediately to your account at Target if you are automatically approved.

How Do I Close My Target RedCard?

You can call Target’s toll-free number or close it via mail.

The Bottom Line

Target’s RedCard can be used for both in-store and online ordering for user convenience. Once a customer is signed up, Target begins to collect data from that individual’s profile. The program is appealing to shoppers because it provides generous discounts and community donations.

However, users should be aware of the high interest rate and the late payment fees, which could cause debt to mount if the balance is not paid off each month.

Reviewed by Somer Anderson
Fact checked by Ryan Eichler

What Is Business Forecasting?

Business forecasting involves making informed guesses about certain business metrics, regardless of whether they reflect the specifics of a business, such as sales growth, or predictions for the economy as a whole. Financial and operational decisions are made based on economic conditions and how the future looks, albeit uncertain.

Key Takeaways:

• Forecasting is valuable to businesses so that they can make informed business decisions.
• Financial forecasts are fundamentally informed guesses, and there are risks involved in relying on past data and methods that cannot include certain variables.
• Forecasting approaches include qualitative models and quantitative models.

Understanding Business Forecasting

Companies use forecasting to help them develop business strategies. Past data is collected and analyzed so that patterns can be found. Today, big data and artificial intelligence have transformed business forecasting methods. There are several different methods by which a business forecast is made. All the methods fall into one of two overarching approaches: qualitative and quantitative.

While there might be large variations on a practical level when it comes to business forecasting, on a conceptual level, most forecasts follow the same process:

1. A problem or data point is chosen. This can be something like “will people buy a high-end coffee maker?” or “what will our sales be in March next year?”
2. Theoretical variables and an ideal data set are chosen. This is where the forecaster identifies the relevant variables that need to be considered and decides how to collect the data.
3. Assumption time. To cut down the time and data needed to make a forecast, the forecaster makes some explicit assumptions to simplify the process.
4. A model is chosen. The forecaster picks the model that fits the dataset, selected variables, and assumptions.
5. Analysis. Using the model, the data is analyzed, and a forecast is made from the analysis.
6. Verification. The forecast is compared to what actually happens to identify problems, tweak some variables, or, in the rare case of an accurate forecast, pat themselves on the back.

Once the analysis has been verified, it must be condensed into an appropriate format to easily convey the results to stakeholders or decision-makers. Data visualization and presentation skills are helpful here.

Types of Business Forecasting

There are two key types of models used in business forecasting—qualitative and quantitative models.

Qualitative Models

Qualitative models have typically been successful with short-term predictions, where the scope of the forecast was limited. Qualitative forecasts can be thought of as expert-driven, in that they depend on market mavens or the market as a whole to weigh in with an informed consensus.

Qualitative models can be useful in predicting the short-term success of companies, products, and services, but they have limitations due to their reliance on opinion over measurable data. Qualitative models include:

1. Market research: Polling a large number of people on a specific product or service to predict how many people will buy or use it once launched.
2. Delphi method: Asking field experts for general opinions and then compiling them into a forecast.

Quantitative Models

Quantitative models discount the expert factor and try to remove the human element from the analysis. These approaches are concerned solely with data and avoid the fickleness of the people underlying the numbers. These approaches also try to predict where variables such as sales, gross domestic product, housing prices, and so on, will be in the long term, measured in months or years. Quantitative models include:

1. The indicator approach: The indicator approach depends on the relationship between certain indicators, for example, GDP and the unemployment rate remaining relatively unchanged over time. By following the relationships and then following leading indicators, you can estimate the performance of the lagging indicators by using the leading indicator data.
2. Econometric modeling: This is a more mathematically rigorous version of the indicator approach. Instead of assuming that relationships stay the same, econometric modeling tests the internal consistency of datasets over time and the significance or strength of the relationship between datasets. Econometric modeling is applied to create custom indicators for a more targeted approach. However, econometric models are more often used in academic fields to evaluate economic policies.
3. Time series methods: Time series use past data to predict future events. The difference between the time series methodologies lies in the fine details, for example, giving more recent data more weight or discounting certain outlier points. By tracking what happened in the past, the forecaster hopes to get at least a better-than-average view of the future. This is one of the most common types of business forecasting because it is inexpensive and no better or worse than other methods.

Criticisms of Forecasting

Forecasting can be dangerous. Forecasts become a focus for companies and governments mentally limiting their range of actions by presenting the short to long-term future as pre-determined. Moreover, forecasts can easily break down due to random elements that cannot be incorporated into a model, or they can be just plain wrong from the start.

However, business forecasting is vital for businesses because it allows them to plan production, financing, and other strategies. However, there are three problems with relying on forecasts:

1. The data is always going to be old. Historical data is all we have to go on, and there is no guarantee that the conditions in the past will continue in the future.
2. It is impossible to factor in unique or unexpected events or externalities. Assumptions are dangerous, such as the assumption that banks were properly screening borrowers prior to the subprime meltdown. Black swan events have become more common as our reliance on forecasts has grown.
3. Forecasts cannot integrate their own impact. By having forecasts, accurate or inaccurate, the actions of businesses are influenced by a factor that cannot be included as a variable. This is a conceptual knot. In a worst-case scenario, management becomes a slave to historical data and trends rather than worrying about what the business is doing now.

Negatives aside, business forecasting is here to stay. Appropriately used, forecasting allows businesses to plan ahead for their needs, raising their chances of staying competitive in the markets. That’s one function of business forecasting that all investors can appreciate.

What Are the Main Steps of Forecasting?

Forecasting should (1) start with identifying the problem. It should then (2) gather all the information necessary to solve the problem. After gathering data, (3) a business should run a preliminary analysis, (4) choose an appropriate forecasting model, (5) and once the forecasting is complete, analyze the results.

Is Forecasting a Business Strategy?

Forecasting is more of a business technique or tool than a business strategy. It seeks to take historical data and apply it to current data to predict the future business environment. From there, a business will make decisions to adapt to this predicted environment to ensure success.

What Do Business Forecasting Models Answer?

Business forecasting models seek to answer a variety of questions for a business, such as demand for a product or service, the ability to compete in an environment, predicting future sales, and estimating growth and expansion.

The Bottom Line

Businesses use forecasting to help make decisions about the direction of the company. Forecasting aims to predict the future to a degree and by doing so can help companies allocate resources, and make decisions on capital allocation, staffing, advertising, and more. Without forecasting, a business operates in the dark and may not be able to adjust itself to the right path for earnings success.

Fact checked by Betsy Petrick

A home equity loan is a type of second mortgage that allows you to borrow against the equity you have in your home, using your home as collateral. They typically have lower interest rates than other personal loans and provide fixed interest rates and regular monthly payments. To take out a home equity loan, determine how much money you want to borrow, shop around for lenders, complete an application, and work with the lender. We’ll walk you through each of these steps in detail.

Key Takeaways

• A home equity loan is often called a second mortgage because you borrow against the equity you have in your home and make regular monthly payments on the loan.
• Lenders will check your home equity, debt-to-income ratio, credit history, income, and assets to determine whether or not to approve your application.
• Homeowners with great credit will qualify for better interest rates and loan terms.

Step 1: Make Sure You Meet the Requirements

Applying for a home equity loan can be quite a process, so check to see if you meet the requirements before you spend time filling out paperwork. Specifically, you should find out your credit score to see if it’s at least in the mid-600s. If it’s lower, work on building your credit before starting a home equity loan application. While this can take time, having a better credit score can greatly improve your chance of getting approved.

While you’re looking into your credit score, check your credit report for errors. If you spot any, reach out to the credit monitoring bureaus and submit a dispute. Potential lenders will read your credit report to see how many credit accounts you have and if you’ve been late on any payments.

Tip

Access your credit reports for free through AnnualCreditReport.com, a government-sponsored site that provides free weekly access to reports from Equifax, Experian, and TransUnion, the three major credit bureaus.

Lenders will also consider your debt-to-income (DTI) ratio. This is the percentage of your income that goes towards monthly debts. Generally, lenders want borrowers with DTIs below 36%, but some may work with you if your DTI is up to 43%. To improve your odds of getting approved, work on paying down debt (like student loans, medical bills, and credit card debt) or earning more income.

Lastly, it’s important to learn how much equity you have since lenders will only consider your application if you have at least 20% equity in your home. For example, if you have a $400,000 home and have $320,000 left on the mortgage, you have the necessary 20% equity. Most lenders allow you to borrow up to 85% of your current equity.

Step 2: Determine How Much You Want to Borrow

You should already know how much equity you have in your home, so you also have an idea of the maximum you can borrow. Using our previous example, if you have a $300,000 home and no mortgage, a lender might offer you a maximum of $240,000, which is 80% of your equity. But, if you still owe $150,000 on the home, you’d subtract this from the potential loan amount, so you’d only be eligible to get $90,000.

Before you accept the maximum offered, consider how much you truly need to borrow. After all, by taking out a second mortgage, you’re reducing your equity and adding a hefty monthly payment to your budget. If you fail to make payments, you risk losing your home.

Think carefully about how much you want your loan to be, keeping in mind that you will be reducing the equity in your home and increasing your monthly debt obligation. You’ll also be paying closing costs, which will reduce the lump sum amount you get. Your goal should be to borrow just enough rather than taking more than you need.

Step 3: Compare Interest Rates and Lenders

Once you have an idea of how big of a loan you want to get, you can begin shopping for home equity lenders. Resist the urge to skip this step and use the first lender you come across.

The terms and interest rates offered by lenders can vary widely, which can cost or save you hundreds or thousands of dollars. Look for legitimate lenders from banks, credit unions, and mortgage brokers. Then, request quotes and compare them based on:

• Interest rates
• Loan term options (like term length and repayment options)
• Closing costs
• Fees (like prepayment penalties)

Step 4: Complete a Home Equity Loan Application 

Once you’ve chosen a lender and home equity loan product, you can complete an application. Some lenders allow you to submit an application online or over the phone, while others require you to apply in person.

You’ll usually need to provide the following information on your application:

• Contact information and proof of identity
• Details about your home (like the title and property tax statements)
• Loan needs—how much you’re applying for
• Income documentation (like paystubs, W2s, and federal tax returns)
• Permission for a credit check

Note

You might assume that if you have the best credit score possible (850), you’ll get the best interest rates on the home equity loan. However, meeting the lender’s minimum requirements, having other accounts at the institution, and signing up for automatic payments also can help qualify you for the same top rate even if your credit score falls well short of being perfect.

Step 5: Wait for Approval

Some might say this is the hardest step: waiting. During this time, the lender will closely look over your application and the company’s underwriting team will research and verify the information. You might be asked additional questions or asked to provide more documentation. For instance, the lender may ask you to set up and pay for a home appraisal.

If your application checks out and you meet the lender’s requirements, you’ll be approved. Be aware that you do have the right to cancel a home equity loan within three days if you change your mind or for any reason.

Step 6: Close and Receive Funds

If approved, your lender will tell you the closing date. This is when you’ll sign the loan documents and the funds will be transferred. Since this is a big financial obligation, be sure to read through the paperwork closely before signing.

When all is said and done, it can take anywhere from a few weeks to months between applying for a home equity loan and receiving the funds.

The Bottom Line

In many ways, getting a home equity loan is easier than getting a mortgage, assuming you meet the lender’s requirements. To make the loan application process go more smoothly, research qualifications, check out your credit factors, and consider how big of a loan you need. If you’re unsure whether or not a home equity loan is right for you, talk with a financial advisor about your best options.

Reviewed by Margaret James
Fact checked by Michael Rosenston

The process of budgeting for capital expenditures (capex) is essential for a business to operate and grow in a healthy and profitable way. Capital expenditures are expenses a company makes to sustain and expand its business over a period of years.

A capital expense is the cost of an asset that has usefulness, helping create profits for a period longer than the current tax year. This distinguishes them from operational expenditures, which are expenses for assets that are purchased and consumed within the same tax year.

For example, printer paper is an operational expense, while the printer itself is a capital expense. Capital expenditures are much higher than operational expenses, covering the purchase of buildings, equipment, and company vehicles. Capital expenditures may also include items such as money spent to purchase other companies or for research and development. Operational expenses are just what their name signifies, the expenses required for the company to operate from week-to-week or month-to-month.

Capital expenditures carry both benefits and risks. Investing in capex can improve the efficiency of a firm, can allow firms to gain a competitive edge, while at the same time they may fail to perform as expected, resulting in losses that could have been allocated elsewhere.

It’s important to create a sound capital expenditure plan to avoid any expense overruns. Because capital expenditures represent substantial investments of cash designed to show a return on the capital investment over a period of years, they need to be carefully planned. Taking into consideration all costs, market expectations, and business growth, is crucial when drafting a capex plan.

Capital Expenditure Planning

Preparing a capital expenditure budget varies from one company to another depending on such factors, such as the nature of the company’s business and the size of the company.

Separating Expenditure Budgets

Most companies budget their capital expenditures separately from other expenditures. Having a separate budget from operational expenses, for example, makes it simpler for companies to calculate the respective tax issues. For operational expenses, deductions apply to the current tax year, but deductions for capital expenditures are spread out over the course of years as depreciation or amortization.

Department Input

Much of the need for capex comes from the assessment of department heads, who run the day-to-day operations of a certain group. They are well aware of any issues within their group that would need updating or replacement. This bottom-up approach assessment helps determine whether any capex expenditures are beneficial for long-term growth, what is economically feasible, and what the return on the investment will be. In the end, capital expenditures are inevitably determined by upper management and owners.

Implementing a Budget Limit

Determining the max spend on capital is a crucial early step in capex planning. Making a thorough assessment of capex needs, whether this is for maintenance, new acquisitions, or growth, from different departments, determines the range in how much to budget for capex. Once a company decides its spend limit, it can shape a plan around that.

Measuring Capital Expenditure Returns

Once the input from different departments has been assessed, a budget decided based on need and business growth, and capital expenditures completed, it’s imperative a company determine the returns on their capital expenditure. This will allow them to determine if their valuations were correct, whether or not the investments are paying off, what went right and what went wrong, so during the next capex cycle, these decisions are continued or improved.

Many financial tools are available in assessing the returns of capital expenditures, particularly the timeframe in which the investments will start to payback. Return on investment ratios, hurdle rates, and payback periods are areas to analyze when determining the benefit of a capital expenditure.

Management’s Role in Capital Expenditures 

For one thing, capital budgeting involves very large expenditures, and it is management that must make the evaluation as to whether the investment in assets is worth the cost. Capital expenses almost always impact operational expenses as purchased items need to be maintained and the “big picture” needs to be considered.

Management must make the call on whether capital expenditures come directly from company funds or if they must be financed. Financing increases the debt level of a firm, which also needs to be taken into consideration. Leasing is an option as well, one that becomes appealing if a company is purchasing assets such as computers or other technology equipment—items that can quickly become obsolete.

In deciding on capital expenditure for a certain item, a company’s management makes a statement about its view of the company’s current financial condition and its prospects for future growth.

Capital budgeting decisions also give an indication regarding what direction the company plans to move in the years ahead. Capital expenditure budgets are commonly constructed to cover periods of five to 10 years and can serve as major indicators regarding a company’s “five-year plan” or long-term goals.

The Bottom Line

Capital expenditures are a large cost for a company but usually necessary. They come with many benefits and many risks, which is why it is imperative to create a sound and thorough capital expenditure budgeting plan that takes into consideration all variables. If a company can do this correctly and execute capex investments appropriately, it will lead to positive growth and success for the firm.

Reviewed by Charlene Rhinehart
Fact checked by Kirsten Rohrs Schmitt

Accrued Expenses vs. Accounts Payable: An Overview

Companies must account for any expenses incurred in the past because these are costs that come due in the future. Accrual accounting is the general accounting term that covers any of these liabilities. Companies use two methods to track these accumulated expenses: accrued expenses or accounts payable.

Both are liabilities that businesses incur during their normal course of operations, but they’re inherently different. Accrued expenses are liabilities that build up over time and are due to be paid. Accounts payable are current liabilities that will be paid in the near future.

Key Takeaways

• Accrued expenses and accounts payable are two methods used by companies to track accumulated expenses under accrual accounting.
• Accrued expenses are liabilities that build up over time and are due to be paid.
• Accounts payable are liabilities that will be paid in the near future.
• The amount owed under an accrued expense can change because it may be an estimate. An account payable comes at a fixed amount.
• Accrued expenses are adjusted and recorded at the end of an accounting period. Accounts payable appear on the balance sheet when goods and services are purchased.

Accrued Expenses

Accrued expenses are payments that a company is obligated to make in the future for goods and services that were already delivered. A company receives a good or service and incurs an expense. This expense is recorded on the books but is paid later.

The term “accrued” means to increase or accumulate. Its unpaid bills increase when a company accrues expenses. They’re recognized under the accrual method of accounting at the time they’re incurred, not necessarily when they’re paid.

Also called accrued liabilities, these expenses are realized on a company’s balance sheet and are usually current liabilities. Accrued liabilities are adjusted and recognized on the balance sheet at the end of each accounting period. Any adjustments that are required are used to document goods and services that have been delivered but not yet billed.

Examples of accrued expenses include:

• Utilities that were used for the month but an invoice wasn’t received before the end of the period
• Wages that are incurred but payments have yet to be made to employees
• Services and goods that were consumed but no invoice has been received yet

Important

Balance sheets are financial statements that companies use to report their assets, liabilities, and shareholder equity. They provide management, analysts, and investors with a window into a company’s financial health and well-being.

Accounts Payable

The term “accounts payable (AP)” refers to a company’s ongoing expenses. These are generally short-term debts that must be paid off within a specified period, usually within 12 months of the expense being incurred. They’re short-term IOUs issued by billing parties. Companies that fail to pay these expenses run the risk of going into default: the failure to repay a debt.

An account payable is essentially an extension of credit from the supplier to the manufacturer. It allows the company to generate revenue from supplies or inventory so the supplier can be paid. Companies can pay their suppliers at a later date. This includes manufacturers that buy supplies or inventory from suppliers that extend the terms for the payment.

Accounts payable are often simply called payables. They might not be due for another 30, 60, or 90 days. They’re considered current liabilities. Companies recognize their payables on the balance sheet when they purchase goods or services on credit. This requires a double entry on the general ledger:

• A credit to the company’s accounts payable upon receipt of the invoice
• An offsetting debit under the expense account for the credit purchase

Key Differences

Accrued expenses are the total liability that’s payable for goods and services consumed or received by the company. All companies have accrued expenses, but they reflect costs for which an invoice or bill hasn’t yet been received. Accrued expenses can sometimes be an estimated amount of what’s owed as a result. This is later adjusted to the exact amount when the invoice has been received.

Accounts payable is the total amount of short-term obligations or debt that a company has to pay to its creditors for goods or services bought on credit. The vendor’s or supplier’s invoices have been received and recorded. Payables should represent the exact amount of the total owed from all the invoices received.

Some other differences between these two expenses include:

• Timing: The major difference in identifying these two liabilities is their timing. Accounts Payable are recorded when an invoice is issued by a supplier. Accrued expenses are booked at the end of the accounting period to recognize the expenses that have been incurred but not yet invoiced.
• Recipient: Companies pay accrued expenses to their employees, property owners, and banks. Salaries, rent, and interest are common accrued expenses that companies owe. Accounts payable are owed to creditors, including suppliers for goods and services purchased on credit.
• Occurrence: Accrued expenses tend to be regular occurrences, such as rent and interest payments on loans. Accounts payable only occur when a business makes a purchase on credit.”

Differences Between Accrued Expenses and Accounts Payable
	Accrued Expenses	Accounts Payable
Types	Employee wages, rent, and loan interest	Supplies, raw materials, and any other orders made with suppliers and vendors
Accounting	As current liabilities on the balance sheet	As accounts payable on the balance sheet
Realization	At the end of the accounting period	When the bill is received for the purchase
Payable to	Employees, property owners, and banks	Suppliers, vendors, and other creditors
Occurrence	Regular occurrences for all companies	When purchases/orders are made on credit

Accrued Expenses vs. Accounts Payable Example

Let’s say a company pays salaries to its employees on the first day of the following month for services received in the prior month. An employee who worked for the entire month of June will be paid in July. The accrued expenses from the employees’ services for December will be omitted if the company’s income statement at the end of the year recognizes only salary payments that have already been made.

Now, imagine that a business receives a $500 invoice for office supplies. It records a $500 credit in the accounts payable field and a $500 debit to office supply expense when the AP department receives the invoice. Anyone who looks at the balance in the accounts payable category will see the total amount that the business owes all of its vendors and short-term lenders.

The company then writes a check to pay the bill so the accountant enters a $500 credit to the checking account and enters a debit for $500 in the accounts payable column.

Explain Like I’m 5

Consider a company that buys materials from a supplier to make its shoes but doesn’t pay for them right away. There are two ways the company can keep track of this expense: accrued expenses or accounts payable.

Both of these mean that a business needs to pay its supplier, but each happens at different times and in different ways. Accrued expenses mean when a company uses something, like its materials, but hasn’t gotten a bill yet. The company writes it down so it remembers to pay it later.

Accounts payable is when the company has gotten the bill, such as an invoice, and knows exactly how much it has to pay and when. The main difference between the two is whether the bill has arrived or not. If it hasn’t, it’s an accrued expense; if it has, it’s accounts payable.

When Should You Accrue an Expense?

Companies usually accrue expenses on an ongoing basis. They’re current liabilities that must typically be paid within 12 months. This includes expenses like employee wages, rent, and interest payments on debts that are owed to banks.

How Are Accrued Expenses Recorded?

Accrued expenses are listed on a company’s balance sheet. They should appear at the end of the company’s accounting period. Adjustments are made using journal entries that are entered into the company’s general ledger.

What Are Examples of Accounts Payable?

Accounts payable refers to any current liabilities that are incurred by companies. Examples include purchases made from vendors on credit, subscriptions, or installment payments for services or products that haven’t been received yet. Accounts payable are expenses that come due in a short period, usually within 12 months.

Is Rent an Account Payable?

Rent is generally not considered part of accounts payable. Companies incur rent as an accrued expense because this is a cost that’s paid consistently and monthly.

The Bottom Line

Companies use two methods to track accumulated expenses: accrued expenses or accounts payable. Both are liabilities that businesses incur during their normal course of operations, but they’re different. Accrued expenses are liabilities that build up over time and are due to be paid. Accounts payable are current liabilities that will be paid in the near future.

Reviewed by Michael J Boyle
Fact checked by Ryan Eichler

Have you ever thought of where your food comes from? The world’s top four food-producing countries by agricultural value are China, India, the U.S., and Brazil. These countries have large populations, ample land area, and climate zones suitable for growing a variety of crops. But, there are major differences in how food production plays in their economies. In this article, we examine the agricultural strengths and weaknesses of each of the four leading food producers.

Key Takeaways

• The world’s top food-producing countries are China, India, the U.S., and Brazil
• China is the world’s largest grain producer, yet is more dependent on food imports.
• Much of India’s output is produced by subsistence farmers and consumed locally.
• The U.S. is the world’s top food exporter thanks to high crop yields and extensive agricultural infrastructure.
• The world’s fourth-largest food producer and second-largest importer, Brazil is heavily dependent on imports from China.

China

As of most recent data from 2023, China was by far the world’s leading agricultural producer with annual output valued at $1.69 trillion—$1.65 trillion was attributed to food, according to the Food and Agriculture Organization (FAO) of the United Nations. A key factor was China’s status as the world’s second-most populous country with a population of 1.42 billion as of 2025, slightly under India’s 1.46 billion.

China has only 10% of the world’s arable land yet produces a quarter of the global grain output and leads the planet in the production of cereals, cotton, fruit, vegetables, meat, poultry, eggs, and fishery products, according to FAO. While much of China’s territory is too mountainous or too arid for farming, the rich soils of its eastern and southern regions are extremely productive.

China also has one of the world’s largest pools of agricultural labor. Though the proportion of workers in food production has decreased steadily from 60% in 1991, farm work still accounted for 25% of national employment as of 2019.

Despite the growth of China’s agricultural output, it reportedly went from full self-sufficiency in food production as of 2000 to relying on imports for more than 23% of its food needs by 2020. Declining soybean output, rising grain imports, and the continuing loss of farmland to industrial and urban development were blamed.

In 2023, China was the world’s top importer of agricultural products, with imports valued at $140 billion. The strong value of imports is largely due to rising consumer demand. Top exporters to China included Thailand, New Zealand, Brazil, and the U.S.

Important

Agricultural output includes both food and non-food products. Examples of non-food agricultural goods include silk, rubber, wool, cotton, and tobacco.

India

The world’s largest country by population, India had the second-highest agricultural output at $553.69 billion in 2023. Of that total agricultural output, $516.62 billion was attributable to food production.

India is the world’s largest producer of milk, jute, and pulses (a class of legumes that includes dry beans, lentils, and chickpeas). India is also the world’s second-largest producer of rice, wheat, sugarcane, fruit, vegetables, cotton, and groundnuts.

Despite achieving self-sufficiency in grain production, India remains heavily reliant on subsistence agriculture as by far the poorest country on this list on a per capita basis. This has dictated the inefficient use of limited resources, particularly water, leaving output dependent on seasonal monsoons and crop yields below the global average. Shortcomings in infrastructure and the distribution systems for produce have caused post-harvest losses of up to 40% for some crops.

Despite such obstacles, India remains the world’s largest exporter of refined sugar and milled rice. Strong exports of rice, cotton, soybeans, and meat made India take the ninth place among global agricultural exporters in 2022.

The United States

The U.S. ranked third in 2023 agricultural output at $459.85 billion—$443.15 billion of which was food— despite employing a small fraction of the agricultural workforce of China or India. Corn, soybeans, dairy, raw milk, wheat, and sugar beets were the top five U.S. agricultural commodities by value in the same year.

Cereal crop yields and output have continued to rise despite a significant decline in planted acreage in recent decades.

The U.S. was by far the leading global agricultural exporter in 2023 with exports valued at $171.15 billion. Canada, China, Mexico, and Japan are also among the leading importers of U.S. agricultural products.

California accounted for 11.5% of U.S. agricultural production in 2023 with dairy, grapes, and cattle among its top commodities. Other major agricultural producers include Iowa, Nebraska, Texas, and Illinois.

Important

After a downturn in the early stages of the COVID-19 pandemic, the prices of key agricultural commodities rebounded in 2021, then soared to record highs in early 2022 as Russia’s invasion of Ukraine jeopardized supplies from two major grain exporters.

Brazil

Brazil was the world’s fourth-ranked agricultural producer in 2023 with output valued at $281.74 billion. Brazil’s agricultural output of food was $270.58 billion.

The Brazilian economy has historically focused on agriculture, particularly sugarcane. The proportion of the workforce employed in agriculture has declined steadily over the past three decades, from 20% in 1991 to 8% by 2023.

Brazil is the top global exporter of soybeans, raw sugar, and poultry. Its soybeans exports of $53.1 billion in 2023 were the largest for an agricultural commodity from a single country. China accounted for almost $56 billion of Brazil’s agricultural exports that year, almost 10 times more than the second-largest importer.

Which Countries Produce the Most Food?

China, India, the United States, and Brazil are the world’s top agricultural producers, in that order.

Which Country Is the Largest Agricultural Exporter?

The United States is the largest exporter of agriculture, accounting for 9.6% of total global export value in 2022.

Which Countries Produce the Most Food Waste?

Many countries contribute to food waste. According to the United Nations, an estimated 1.05 billion tonnes of food was wasted in 2022 globally. China, India, and Pakistan had the highest amounts of food waste in 2024, with 108.7 million, 78.2 million, and 30.8 million tonnes annually.

The Bottom Line

Many factors influence the level of food production in a country, including land area, size of population, climate, and the quality of agricultural infrastructure and technology. While the U.S. is the top exporter of agricultural commodities, other countries including China, India, and Brazil have emerged as major food suppliers.

How to decide if Medicare Supplement Insurance is worth it for you

Reviewed by Ebony Howard
Fact checked by Jared Ecker

If you are covered by Medicare you may be wondering if you need a Medicare Supplement Insurancepolicy, also known as Medigap. Read on to see what a Medigap plan is and how it works.

Key Takeaways

• Medigap pays some or all of the costs Medicare doesn’t cover, depending on the level of coverage you choose.
• Medicare alone may not cover extensive treatment or long-term hospitalization.
• Many private insurance companies offer Medigap policies.

What Is Medigap?

Medigap is a supplement to Medicare coverage and policies are designed to provide additional coverage for routine services Medicare covers and, in some cases, all or part of the expenses Medicare does not cover, such as long-term care, vision, or dental coverage.

A Medigap plan helps individuals get reimbursed for the costs they pay directly out of their pocket. These plans are offered by private insurance companies, so it is necessary to compare plans that fit your needs and financial situation.

What Medicare Covers

Medicare consists of Parts A and B along with Medicare prescription drug coverage found in optional Part D. Even routine services come with co-payments and deductibles. Prescription drugs can also deplete your budget if you need expensive medications.

Under the Affordable Care Act (ACA), the prescription price donut hole has been closing each year. At a certain level, $5,030 in 2024, you entered the notorious donut hole in coverage that requires you to pay up to 25% of covered brand-name and generic drug costs. When costs went above $8,000, you pass through the donut hole and owe only 5% of the cost of drugs.

What Medicare Doesn’t Cover

Medigap will help pay for costs that Medicare does not cover. If you are admitted to the hospital, you have 100% hospitalization coverage after the $1,676 annual deductible under Original Medicare Part A in 2025. However, you may owe up to 20% of some other costs, such as anesthesiologist fees.

If you are in the hospital for more than 60 days, you have to pay $419 per day in 2025. There are similar co-payments for long stays in nursing facilities and hospices. Regular doctor visits and outpatient medical care may cost you, too. Your deductible for 2025 is $257, but after that, you’ll pay up to 20% of the Medicare-approved amount for most doctor services. There is no upper limit.

If you do not have coverage for dental expenses, you may want to look into a standalone dental insurance plan. Many plans provide coverage for the types of dental procedures that Medicare recipients may need, including crowns, root canals, dentures, and tooth replacements.

Types of Medigap Plans

Medicare Parts A and B comprise basic coverage, while Part D is an optional prescription drug plan you can buy from a private provider and attach to your Medicare. If you opt for Original Medicare (A and B), plus Part D, and want a Medigap plan for more complete coverage, the most popular choices are Medigap Plan F and Medicare Plan G.

Medigap plans and benefits are fully defined at Medicare.gov.

Medigap Plan F: As of January 1, 2020, Plan F is no longer available to those newly eligible for Medicare. People who already have Plan F will be able to keep it, and people who were eligible for Medicare before 2020 but didn’t have a Medigap plan may still be allowed to choose Plan F.

Medigap Plan G: This plan has almost the same coverage as Plan F except for reimbursement of the Part B deductible. The average Plan G may be cheaper than Plan F. However, costs vary widely according to an applicant’s zip code, gender, and tobacco use, and increase with age.

Medigap Plan K: This plan provides less coverage than F or G and includes an out-of-pocket expense of $7,220 for 2025.

Medigap Plan L: This plan provides less coverage than F or G and includes an out-of-pocket expense of $3,610 for 2025.

Medigap Plan M: This plan offers similar coverage to F and G with some limitations.

Medigap Plan N: This plan offers similar coverage to F and G with some limitations.

Important

Part C, also known as Medicare Advantage, replaces all of the basic government coverage with a private insurance plan; if you choose Part C, you do not need a Medigap Plan.

Medigap vs. Plan C Medicare Advantage

A Medigap policy is a supplement to Parts A and B coverage and pays expenses that Original Medicare doesn’t. A Medicare Advantage Plan (Medicare Part C) is a private replacement for the public Medicare program.

Most of these plans are set up as health maintenance organizations ((HMOs) that replace all of the services of Original Medicare and add additional services, such as preventive health care, within a preselected network of doctors and hospitals.

A Medigap plan, however, gives you more freedom of choice than Medicare Advantage, provided your physician or facility accepts Medicare. As long as you pay your premiums, your policy is renewable for the rest of your life and will only be dropped if you stop paying premiums, you falsify your application, or the insurance company files for bankruptcy.

Warning

Individuals cannot have Medigap and a Medicare Advantage Plan C at the same time.

Is My Spouse Covered Under My Medigap Policy?

No. A Medigap policy covers only one person and doesn’t cover expenses incurred by your spouse. Medicare isn’t like an employer-sponsored plan; you can’t enroll your spouse under your coverage. This means you and your spouse have to purchase separate plans to be covered for supplemental insurance.

How Much Does Medigap Cost?

Since Medigap is privatized insurance, each insurance company offers different premiums for its Medigap policies. The price will be determined by factors such as your age, or how long you’ve been enrolled in Medicare.

Why Do I Need Medigap?

Medigap policy supplements your Original Medicare coverage. Medigap provides more choices and covers a large network of healthcare providers.

The Bottom Line

Medicare Parts A and B comprise basic coverage, while Part D is an optional prescription drug plan. A Medigap policy will supplement this coverage and help pay additional expenses or deductibles. Individuals who choose Medicare Part C, also known as Medicare Advantage do not need a Medigap Plan.

Reviewed by David Kindness
Fact checked by Vikki Velasquez

Prepaid expenses are payments for goods or services that will be received in the future. These expenses are not initially recorded on a company’s income statement for the period when the money changes hands.

Instead, prepaid expenses are first recorded on the balance sheet as an asset. But, as the products and services are received, prepaid expenses are recognized on the income statement for each period when the money is spent.

Key Takeaways

• Prepaid expenses are incurred for assets that will be received at a later time.
• Prepaid expenses are first recorded in the prepaid asset account on the balance sheet.
• The GAAP matching principle prevents expenses from being recorded on the income statement before they incur.
• Once expenses are incurred, the prepaid asset account is reduced and an entry is made to the expense account on the income statement.
• Insurance and rent payments are common prepaid expenses.

What Are Prepaid Expenses?

Prepaid expenses are payments made for goods and services that a company intends to pay for in advance but will incur sometime in the future. Examples of prepaid expenses include insurance, rent, leases, interest, and taxes.

Prepaid expenses aren’t included in the income statement per generally accepted accounting principles (GAAP). In particular, the GAAP matching principle requires accrual accounting, which stipulates that revenue and expenses must be reported in the period that the spending occurs, not when cash or money exchanges hands.

In other words, expenses should be recorded when incurred. Thus, prepaid expenses aren’t recognized on the income statement when paid because they have yet to be incurred.

We’ve outlined the procedure for reporting prepaid expenses below in a little more detail, along with a few examples.

Important

Unless the prepaid expense will not be incurred within 12 months, it is recorded as a current asset.

Recording Prepaid Expenses

When a company prepays for an expense, it is recognized as a prepaid asset on the balance sheet, with a simultaneous entry being recorded that reduces the company’s cash (or payment account) by the same amount. Most prepaid expenses appear on the balance sheet as a current asset unless the expense is not to be incurred until after 12 months, which is rare.

Then, when the expense is incurred, the prepaid expense account is reduced by the amount of the expense, and the expense is recognized on the company’s income statement in the period when it was incurred.

Note

Businesses cannot claim a deduction in the current year for prepaid expenses for future years.

Insurance as a Prepaid Expense

One of the more common forms of prepaid expenses is insurance, which is usually paid in advance. This means that the premium you pay is allotted to the upcoming time period.

For example, Company ABC pays a $12,000 premium for directors’ and officers’ liability insurance for the upcoming year. The company pays for the policy upfront and then, each month, makes an adjusting entry to account for the insurance expense incurred. The initial entry, where we debit the prepaid expense account and credit the account used to pay for the expense, would look like this:

Then, after a month, the company makes an adjusting entry for the insurance used. The company makes a debit to the appropriate expense account and credits the prepaid expense account to reduce the asset value. The monthly adjustment for Company ABC would be $12,000 divided by 12 months, or $1,000 a month. The adjusting entry at the end of each month would appear as follows:

Rent as a Prepaid Expense

Businesses may prepay rent for months in advance to get a discount, or perhaps the landlord requires a prepayment given the renter’s credit. Either way, let’s say Company XYZ is prepaying for office space for six months in advance, totaling $24,000. The initial entry is as follows:

Then, as each month ends, the prepaid rent balance sheet account is reduced by the monthly rent amount, which is $4,000 per month ($24,000 ÷ six months). At the same time, the company recognizes a rental expense of $4,000 on the income statement. Thus, the monthly adjusting entry would appear as follows:

Other Prepaid Expenses

Additional expenses that a company might prepay for include interest and taxes. Interest paid in advance may arise as a company makes a payment ahead of the due date. Meanwhile, some companies pay taxes before they are due, such as an estimated tax payment based on what might come due in the future. Other less common prepaid expenses might include equipment rental or utilities.

As an example, consider Company Build Inc., which has rented a piece of equipment for a construction job. The company paid $1,000 on April 1 to rent a piece of equipment for a job that will be done in a month. The company would recognize the initial transaction as follows:

Then, when the equipment is used and the actual expense is incurred, the company would make the following entry to reduce the prepaid asset account and have the rental expense appear on the income statement:

Regardless of whether it’s insurance, rent, utilities, or any other expense that’s paid in advance, it should be recorded in the appropriate prepaid asset account. Then, at the end of each period, or when the expense is incurred, an adjusting entry should be made to reduce the prepaid asset account and recognize (credit) the appropriate income expense, which will then appear on the income statement.

How Do You Record Accrued Expenses on a Balance Sheet?

In finance, accrued expenses are the opposite of prepaid expenses. These are the costs of goods or services that a company consumes before it has to pay for them, such as utilities, rent, or payments to contractors or vendors. Accountants record these expenses as a current liability on the balance sheet as they are accrued. As the company pays for them, they are reported as expense items on the income statement.

Why Are Prepaid Expenses an Asset?

Prepaid expenses are classified as assets because they represent money that the company has not yet spent.

What Is the 12-Month Rule for Prepaid Expenses?

The 12-month rule allows taxpayers to deduct prepaid expenses in the current year if the asset does not go beyond 12 months from the date of the payment or the end of the tax year following the year in which the payment was made.

Who Benefits from Prepaid Expenses?

Individuals and companies both benefit from prepaid expenses. Individuals ensure that they don’t miss payments for important services like health insurance. Companies benefit by increasing cash flow, securing discounts, or qualifying for business deductions.

What’s the Difference Between Prepaid Expenses and Deferred Expenses?

Prepaid expenses and deferred expenses are both recorded as assets on a company’s balance sheet until the expense is realized. They are both advance payments, but there are some clear differences between the two common accounting terms. One of the key differentiators is time.

The Bottom Line

At times, payments are made for future benefits. In accounting, these payments or prepaid expenses are recorded as assets on the balance sheet. Once incurred, the asset account is reduced, and the expense is recorded on the income statement. The GAAP matching principle, however, prevents these expenses from being recorded on the income statement before the asset is realized.