What it is: Depreciation is the accounting practice of allocating the cost of tangible assets (such as equipment, buildings, or vehicles) over their useful life. It reflects the gradual decrease in the value of these assets over time and helps businesses match expenses with the revenue generated by their use.
Why it is important: Depreciation is important for accurately representing the wear and tear or obsolescence of assets in a company's financial statements. It allows businesses to spread the cost of acquiring assets over their useful lives, aligning expenses with the periods when the assets contribute to generating revenue.
Formulas: Various methods can calculate depreciation, including straight-line depreciation, declining balance depreciation, and units-of-production depreciation. The specific formulas depend on the chosen depreciation method and the asset's cost, useful life, and salvage value.
How to use it in the context of startups: Startups can use depreciation to allocate the cost of their assets over time, reducing the impact of significant upfront expenses. By accurately calculating and recording depreciation, startups can reflect the true cost of asset usage in their financial statements and make informed decisions regarding asset replacement or maintenance.