A quick way to improve your company’s bottom-line

What is a quick way to improve your company’s bottom-line?

A business owner can improve the bottom-line on their income statement by improving their capital asset management . That is the depreciation of a capital asset (reducing the value of an asset) instead of expensing it all at once.

Example: you decide to buy new laptops for each of your managers so they can be more productive. You buy 5 new units at $600 each. That’s $3,000 of expense on the income statement. Booking this purchase as an expense reduces your net operating income by $3,000. Thus, lowering your net income ratio.

However, the alternative is to book the transaction as a capital expenditure and record just the depreciation on your income statement. Normally, office equipment is depreciated over 5-7 years. This is called the equipments useful life.

There are a few methods of depreciation. The most common is the straight line method. This is the process of reducing the value of the asset (depreciating it) equally over a set number of years.

So, instead of $3,000 of expense hitting your income statement you will record $300 the first year. Why $300 you say and not $600? Well, normally purchases are not always made on the first business day of a company’s fiscal calendar. So in order to account for this timing the first year of depreciation is split half on the front end and half on the back end. The percentage breakdown for a five year depreciation would look as follows:

10%, 20%, 20%, 20%, 20%, 10%

Or in the example above $300, $600, $600, $600,$600,$300

The respective amount will be expensed to your income statement each year in the form of depreciation instead of a one time hit of $3,000. The first year impact to net income will be a fraction of the amount it would have been if you expensed it all at once.

Also, as an added bonus you will decrease the negative impact on your balance sheet by depreciating vs expensing.

Normally, an expensed item has an impact on both the balance sheet and the income statement. First by reducing cash (an asset) and second by increasing expenses on the income statement.

Again using the laptop example, if they were expensed then your balance sheet would have shown a reduction in cash (asset) by $3,000. This is assuming the purchase was made out right and not financed. The off setting effect to the balance sheet would have been a negative impact to owners equity via the lower net income.

Now a portion of the value moves from one type of asset to another. This is done by depreciating the equipment vs. expensing it. It’s no longer a current asset (cash) but now it’s a fixed asset (equipment).

So, the current asset section is reduced by $3,000, fixed asset is increased by $2,700 and depreciation is increased by $300. This only impacts owner’s equity by $300 vs $3,000 in the first year. Now the business shows a higher net income and less of an impact to owners equity.

All what I have explained is standard accounting practices. In some tax situations it may actually be better to expense some items. Also, not every purchase can be capitalized. It depends on your company threshold and Generally Accepted Accounting Principles (GAAP).

Yet, all to often these types of purchases are not tracked properly by a business owner and could be missed by a bookkeeper. So, consult with your CPA on the best way to track business purchases and stop letting the value leak out of your company.

Don't let your business value go down the drain!