Save Business Costs By Understanding Depreciation

One of the fundamentals of business accounting and finance is depreciation. It sounds complicated, but it really isn't - all it basically means is that the fixed assets of your company will go down in value over time.

For example, a computer you bought two years ago would be much cheaper for the same specification now, since components and processors are much cheaper. We all know how quickly cars depreciate in value once they leave the showroom, and assets in a business are no different.

The use of depreciation is essential, since it's a good tax-saving measure. You shouldn't have your assets valued at more than they are worth, because if it ever came to valuating or selling them as part of the business, if you haven't allowed for depreciation, you'll have an inaccurately high figure as to their worth - one that will affect your accounts.

Fixed assets - what are they?

This is one of the areas that confuses people new to finance. Boiled down to the most basic level, a fixed asset is described as 'fixed' because it's always with the business (unlike stock or products that you're selling, even though they are assets).

For example, if you were running an accountancy business, the fixed assets would be the desk, chairs, meeting tables and other furniture, and also the computers and printers. In a construction company, it would be the vans, the machinery, the hard hats, and so on.

Straight line depreciation on accounts

In order to use depreciation as part of your accounts, you need to make a note of certain information about the fixed assets that you think qualify for depreciation.

First, make a note of the nature of the item (for example, a desk). Then there's the date - usually the date you bought it - that it started being used in the business (for example, you can't depreciate a brand new desk that would still be in its wrapping, unused in your warehouse for a year). Then the cost of the item, and finally - the number of years that it is considered to have a 'useful life' - i.e. the time before it will be replaced.

There are some generally-known depreciation figures that are out there - for example, it's estimated that a computer will lose 33% of its value per year, and its useful life is about three years before an upgrade or new system is needed. This is based on straight-line depreciation, though - and you need to state what kind of accounting depreciation system you're using when writing the accounts. Out of all the many methods, straight line is the most common.

This is just a very basic introduction to depreciation, but it's something that you need to understand in order to capitalise on it in your own business. Accountants are all well and good and will do the bulk of the work, but if you don't understand some of the elements of accounting such as depreciation, then you won't be able to correct any mistakes made on the balance sheet, because you won't be sure what it means.

This is just one of the basics that a non-financial manager needs to know. To brush up on more skills, consider taking a training course in an introduction to such finances, and perhaps the basics of account. It will only help you, and the business, in the long run.