Most assets, be they cars, factory equipment, computers, or office furniture lose value over time, and this tendency is known as depreciation.
If you’ve ever bought a car and sold it a few years later, chances are good that you lost a bit of money in the deal – and the same applies to almost everything your business owns.
Depreciation is a fact of business, and it also has a strong influence on your taxes and business valuation. Here’s what business owners need to know about this key concept.
Depreciation may sound bad – but it can save you a significant amount in taxes
Assets losing value over the years may seem like a sad fact of life, but the good news is that you can recover some of these losses by writing off depreciation against your taxes.
- The residual value of your business assets (the amount you originally paid minus the depreciation that accumulates each year) will gradually decrease over time.
- When the asset is brand new, there’s no depreciation to show yet, but once it’s reached the end of its useful lifetime in accounting terms it’s considered to be 100% depreciated.
- For this reason, depreciation is calculated over time, with the timeframe used corresponding to the useful lifetime of the asset.
Here’s a small-scale example: a computer that was bought for R10 000 may have a useful life of 4 years.
No matter what the actual market value of this equipment is, accountants depreciate an asset like this equally over its useful lifetime, with R10 000÷4 yielding a depreciation of R2 500 per year.
Depreciation isn’t always that easy to figure out
In practice, there are different types of depreciation, and most assets aren’t as easy to depreciate as the computer in the example above. Luckily, an outsourced accounting solution will handle all of the technicalities related to your business assets.
Since a new piece of machinery will need to be bought once the old one has reached the end of its useful lifetime, the tax authorities allow companies to write off the cost of depreciation every year while the asset is being used.
How depreciation can benefit your business
There are several benefits to understanding depreciation and tracking depreciation of your business assets accurately. They include:
- Tax savings. As mentioned above, depreciation can be written off against your company taxes.
- Company valuation. The value of your business assets contributes to the overall value of your company. If you’re not keeping track of depreciation you could overestimate the value of your company.
- Strategic financial planning. Knowing the lifetime of your assets and when they will be due for replacement can help you plan your investment activities and budget cash for new machinery purchases or secure financing ahead of time.
Calculating depreciation – leave it to the experts
Depreciating assets accurately on financial statements can be tricky, and misstatements on your tax return can result in penalties and fines.