Depreciation is an accounting term used to describe the gradual decrease in the value of a specific asset over time. It is primarily defined on the basis of factors such as wear and tear, obsolescence, and depletion. Generally, assets depreciate over time even without any external factors coming in to play. Therefore, businesses must have a system in place to account for these decreases in asset value, which is done through depreciation.
The Business Use of Depreciation
Depreciation is a commonly used business practice, since it allows businesses to better plan for the future. By accounting for the decrease in value of certain assets, businesses can estimate what they will need to invest in order to replace those assets when they reach the end of their useful life. Depreciation also allows businesses to better manage their cash flow, since they can write off the declining value of their assets and deduct it from their taxable income.
Modern Examples of Depreciation
In the digital age, depreciation is being applied to things that wouldn’t have been traditionally depreciated. For example, technology such as smartphones and laptops lose a significant amount of their value each year, and can be depreciated over their useful lives. Digital assets such as software and websites can also be depreciated in a similar way. Additionally, companies are now beginning to factor in the depreciation of intangible assets such as customer loyalty or intellectual property rights.
The Bottom Line
At the end of the day, it’s important for businesses to understand depreciation so they can plan for the future and manage their cash flow. By calculating the depreciation of their assets, businesses can better estimate their future needs and determine how much they can realistically invest in order to remain competitive. Ultimately, understanding the key concept of depreciation can give businesses a longer-term view of their financial situation and long-term view of their successful operations.