Depreciation recognises that buildings, vehicles, and machines wear out or become outdated. Instead of expensing the full purchase price in year one, companies charge a portion each year against profit. Cash left the business when the asset was bought (or financed); depreciation itself is a non-cash expense that still reduces reported earnings.
Key takeaways
- Depreciation applies to tangible fixed assets; amortisation usually covers intangibles.
- Methods such as straight line and reducing balance change the pattern of expense.
- Add back depreciation when you move from profit toward cash flow analysis.
- Aggressive depreciation assumptions can distort comparisons between firms.