Prepaid expenses are payments made in advance for goods or services that will be received in the future. For example, if a business pays its insurance premium for the entire year upfront, that payment is considered a prepaid expense. It represents a future benefit that the company will use over time. As the service or benefit is utilized, the prepaid expense is gradually recognized as an expense on the income statement. This process ensures that the financial statements accurately reflect the company's expenses in the period they are incurred, following the matching principle in accounting.