The Straight-Line Depreciation Method & Its Effect on Profits

Depreciation is a useful tool for business, because it allows you to purchase needed equipment and supplies for your company without drastically affecting your profits all at once. One of the simplest and most common methods used by businesses for their assets is straight-line depreciation. This accounting method allocates the cost of a long-term asset over a period of time, which affects your profits at an equal and predictable amount per year.

When you purchase assets for your company, the purpose of these assets is to increase the profitability of the business. Now, realistically, this won't happen right away with some assets. Unfortunately, their purchase can negatively affect your profits in the immediate term for accounting purposes. That's where depreciation comes in. Using a depreciation method, you can spread out the cost of your assets over several years, so that they won't negatively affect your profits during the year they are purchased. This allows you to better see how your profits have gone up or down with their use. For example, if your business requires machinery to function, you can allocate the cost of this equipment over a period of time to the expenses on your balance sheet, so that your profits will not be affected all at once.

The straight-line depreciation method is one of the simplest methods to use because it, as its name suggests, depreciates your asset in a straight downward-sloping line. What you'll need to calculate the depreciation of an asset is its purchase price, its useful life and its salvage value after it stops being useful. For example, say you are purchasing manufacturing equipment for your business at a cost of $5,000. This equipment you expect to have a useful life of five years. At the end of the five years, the equipment can be sold for $1,000. Subtract the salvage value from the purchase price to get a figure of $4,000 and divide this by the number of useful years, which is 5. Now, you get $800, which is the value that will affect your profits for the five-year period. This is the "cost" that you will account for each year for the equipment that you purchase for your business.

Straight-line depreciation is an accounting method that is most useful for getting a more realistic view of your profit margins in businesses primarily using long-term assets. These types of assets include office buildings, manufacturing equipment, computers, office furniture and vehicles. These are considered long-term assets, because they will last for more than one year and are necessary to run the business on a day-to-day basis. By dividing out the cost of these assets, you are giving yourself and your investors a complete view of your profit margins, because the equipment is fueling the business. Rather than taking a financial accounting hit immediately and then later seeing seemingly inflated profits, you even out your profits and expenses at an equal rate, using the straight-line depreciation method.

While in the past straight-line depreciation was a useful method to write-off the cost of many long-term assets, newer tax deductions like Section 179 may be better for your profit margin. This deduction allows you to write-off the complete cost of your long-term assets up to $1,000,000 as of 2018. This deduction can positively impact your profit margin. You'll need to discuss this with your tax and accounting professional, to determine if this deduction is right for you.

Straight-line depreciation is the simplest method to use for accounting purposes, but it may not be the best method for your business' profit margin. When purchasing equipment like computers and electronics, your business may benefit from using the double-declining method. This method accelerates the depreciation of the item upfront and slows it down near the end of the item's useful life. Or, when purchasing assets like vehicles, you may benefit from using the units of production depreciation method. This method accounts for higher depreciation during periods of high usage and lower depreciation during periods of low usage.