I Suffer From Depreciation

Some time ago, I was speaking briefly with a Board Member of an organization and he mentioned that “we don’t ever record depreciation during the year.  Do whatever you need to get the books in shape, but don’t ask or make us look at depreciation.”

“Depreciation doesn’t matter.”

“GAAP entries?  Oh, you mean like depreciation.”  (Big sigh follows.)

Depreciation is technically the recognition of a capital expense over the life of the asset.  In other words, if you buy a building for 3.6 million dollars and you believe it will last 40 years, then each year, you will have an expense of $90,000.  Ninety thousand dollars that you have to cover with support, revenues or some other offset on your way to positive net assets.  Ninety.  Thousand.  Dollars.

Oh, and you are probably paying debt service on that building in which the interest is also creating an expense.  Another expense (this time real cash) that you have to cover with support, revenues or some other offset.

Depreciation can cause confusion among non-financial Board and Leadership people in the organization.

Every good cash analysis and operational/management tool adds back depreciation in the first step.

EBITDA – Earnings BEFORE interest, taxes, depreciation and amortization.

Depreciation, depreciation, depreciation – I suffer from depreciation.

So, why do we record it?  Why do we make you look at a large number that represents money already spent?  Why do we set you up to have to explain you have a net loss, but only because of depreciation?

There are some good reasons to record depreciation:

First and foremost, it IS generally accepted accounting principles and if I know that you are handing out “board approved” interim statements for Grant applications or financing or whatever, then I am going to make sure that those interim statements are as close to accurate as possible within an accounting framework.  And that includes depreciation.  This just protects you.

Second,  it can loosely represent future capital needs and if you are covering it with your support in this year, theoretically, you are increasing your cash to meet those needs.

Third, if you are doing a tax return, depreciation is actually the law for certain listed assets.  (Note that tax depreciation and book depreciation can vary widely – one is legislated and one is based on estimated actual life).

Finally, well…  I can’t think of any other reason to record depreciation because, I also don’t like depreciation.  I also add it back at the earliest opportunity. And I also generally think it doesn’t matter.  For my clients, I often take it out of the main expenses and give a net income before depreciation – it is still there, but it is way below the operational data.

BUT, I work with service entities, arts based and community services organizations.  These organizations do not have large capital expenditures for production.  The number one cost on most of my financial statements is payroll – not inventory, not production cost, not warehousing.  There is a place for depreciation in the world of manufacturing, etc. and for those, please carry on.

In the meantime, we will keep recording it because we should and then we will add it back to find our important ratios – debt coverage, operating cash, income from operations.