## How to Calculate Depreciation: A Practical Guide for Businesses and Investors

If you are a business owner or investor looking to understand financial statements, the term "depreciation" might seem mysterious. But in fact, **how to calculate depreciation** is a simpler process than you think and is very important for analyzing a company's financial strength.

### Why is understanding depreciation important?

When a company purchases equipment or major assets, they need to allocate the cost over the period of use. It’s not foolish to deduct the entire cost in the first year because the asset will still provide benefits in subsequent years. This method of depreciation helps make profit and loss figures more realistic and comparable.

Additionally, depreciation directly affects EBIT (Earnings Before Interest and Taxes). If investors compare two companies, one with many machines and another with few, depreciation will make the first appear to have lower profits, even if the actual management performance is similar.

### The true meaning of depreciation

**How to calculate depreciation** has two main concepts:

First, the value of an asset naturally decreases over time. An old ship isn’t as good as a new one, right?

Second, it involves spreading the initial investment over the years of use. For example, if you buy a laptop for 100,000 THB and expect to use it for 5 years, you would normally depreciate 20,000 THB per year.

Since assets have a defined useful life (e.g., a car typically lasts about 5 years), companies can calculate the amount to depreciate each year.

### Assets eligible for depreciation

Tax authorities specify that assets must meet these criteria to be depreciable:

- Owned by the company
- Used to generate income
- Have a clear useful life
- Expected to be used for more than one year

Common assets that can be depreciated include cars, buildings, furniture, computers, machinery, and even intangible assets such as patents, copyrights, and software.

Assets that **cannot** be depreciated include:
- Land (because it does not become obsolete)
- Coins and collectibles
- Stocks and bonds
- Personal property
- Assets with a lifespan less than one year

### The four main methods of depreciation calculation

#### 1. Straight-Line Method(

This is the simplest method: divide the asset’s value by the number of years of useful life. Each year, the same amount is deducted.

**Advantages:** Easy to use, minimal calculations, suitable for small businesses.

**Disadvantages:** May not be realistic because it doesn’t account for faster depreciation in the early years or increased maintenance costs as the asset ages.

)# 2. Double Declining Balance###

This method calculates higher depreciation in the initial years, then decreases in subsequent years. It allows you to recover more value quickly.

**Advantages:** Compensates for increased maintenance costs as assets age; can increase tax deductions in early years.

**Disadvantages:** If the company is already experiencing tax losses, it may not benefit from these deductions.

(# 3. Declining Balance Method)

Similar to the double declining balance but with a less aggressive depreciation rate. It’s considered between straight-line and double declining balance.

#### 4. Units of Production Method(

This method ties depreciation to actual usage, not years. For example, machinery might depreciate based on hours operated or units produced.

**Advantages:** More accurate reflection of asset usage.

**Disadvantages:** Complex and requires careful tracking of usage data.

) The role of EBIT vs EBITDA in depreciation

**EBIT** ###Earnings Before Interest and Taxes( is profit before deducting interest and taxes, including depreciation.

**EBITDA** )Earnings Before Interest, Taxes, Depreciation, and Amortization### is profit **before** deducting depreciation, providing a clearer view of operational cash flow.

The main difference is that EBITDA adds back depreciation to show the company’s cash-generating ability.

( What is amortization?

**Amortization** is similar to depreciation but applies to intangible assets and loans.

For loans: you make monthly payments that include both interest and principal. Initially, most payments go toward interest, but over time, more goes toward reducing the principal.

For intangible assets: you allocate the cost )e.g., a patent costing 10,000 THB( over its useful life )e.g., 10 years = 1,000 THB per year###.

( The main difference between depreciation and amortization

| Criteria | Depreciation | Amortization |
|------------|--------------|--------------|
| **Type of Asset** | Tangible assets )cars, machinery( | Intangible assets )patents, copyrights( and loans |
| **Method** | Straight-line or accelerated | Usually straight-line only |
| **Residual Value** | Considered in calculation | Usually zeroed out |

) Real-world example

Imagine a logistics company buys a truck for 500,000 THB, expected to last 5 years:

- **Straight-line:** Deduct 100,000 THB each year
- **Double declining balance:** Deduct 200,000 THB in the first year, 120,000 THB in the second, decreasing over time
- **Units of production:** If the truck is used for 50,000 km per year, depreciation is based on this usage

Business owners should choose the method that best fits their business.

### Why should investors care?

When analyzing a company, investors should check:

- The depreciation method used
- EBITDA to assess actual cash generation
- Avoid comparing profits of companies with different depreciation methods

A company with many machines might show lower profits due to high depreciation but could actually generate substantial cash flow.

## Summary

**Depreciation and amortization methods** are essential tools in profit and loss accounting, helping figures better reflect reality. Whether you are a business owner or investor, understanding these methods will improve your financial decision-making and give a clearer picture of the company through its numbers.