As business owners, we often overlook one important aspect in the industry – depreciation. Calculating it looks really complicated but getting it right and knowing its importance has benefits in your business.
Depreciation is when a business asset loses value over time. Your work computer eventually and gradually depreciates from its original price with time. You might not see it now but doing business means considering the ins and outs of depreciations.
3 REASONS WHY DEPRECIATION IS VERY IMPORTANT IN YOUR BUSINESS
1. It is an expense
- Depreciation accounting entails how much value your business assets lose every year. This value must be recorded in your P&L report and is considered as a loss and must be subtracted from your revenue. By doing this so, you’ll be able to see how much money you really are making and you won’t be underestimating your costs.
2. Recovers the cost of an asset purchased over time
- Depreciation is a business cost so the process allows for companies to cover the total cost of an asset over its lifespan instead of immediately recovering the purchase cost which would see one large cost and lower profits. This could impact credit rating, investment or dividends you can take out.
- Businesses claim the cost of assets using the capital allowance that can be applied when asset purchased (and annually if needed) against the corporation tax. If you don’t list down your business assets’ depreciation, you’ll end up paying too much tax. And we don’t want that.
3. It affects the value of your business
- Over time, your assets lose value, and so can your business. Inaccurate tracking of these assets could lead to overestimating your business value and making it more difficult to secure finance.
METHODS OF CALCULATING DEPRECIATION
Your asset’s value will decline over it’s lifespan. You have to decide how. Will it lose most of its value early or will it lose value at the same rate every year? There are different methods of calculating depreciation. The most common are:
Straight Line Depreciation
- This method, the asset depreciates the same amount every year until it reaches zero value. A business asset projected to last five years would depreciate by one-fifth of its price yearly.
Reducing Balance Depreciation
- Under this method, an asset loses a certain percentage of its value each year.
- The actual amount being depreciated steadily slows down with time.
Units of Production Depreciation
- The lifespan of some business assets is measured by the work they do rather than the time they serve. A good example for this is a vehicle might travel more certain number of kilometers when purchased and slows down over time. You could depreciate business assets like this based on usage rather than age.
As business owners and for small businesses, calculating depreciation can be overwhelming but keep in mind that these can lower your costs reported as it smooths asset purchases over time and help you track your business value so it’s worth to compute your business assets’ depreciation. If you are not sure where to start or how to go about this, get help from us. Contact us today and we’ll help you with this. You may contact us through 01892 807 001 or email us at firstname.lastname@example.org.