Proceed With Caution: When NOT to Change

If your business is just starting out, there’s a challenge that you’re about to face that you might not even realize. Yes, there are numerous business challenges you’re already going to be wrestling with over time, but here’s one that you need to figure out early.

Fortunately, this decision is a “set it and forget it” decision because once you’ve decided, you shouldn’t change.

I’m talking about depreciation. When you buy an asset, you spend a lot of money all up-front but it won’t always be worth that amount. To use a really simple example, if you bought a $25,000 car and kept it for 10 years, you know it wouldn’t be worth $25,000 in the asset column of your balance sheet the entire time. Cars depreciate just as all assets do.

So here’s the “set it and forget it” decision you have to make:

When you depreciate your assets over time, you have a couple of options:

• One option is called the “straight line” method where you simply depreciate the asset by the same dollar amount every year. So, let’s use the example of that $25,000 car again. If you know it will be worth $2,500, you might consider depreciating the car by $2,250 each year. It’s called the “straight line” method because, if you think of a graph, there’s a straight line that descends year by year from $25,000 in the first year to $2,500 in the tenth year.

• The second option is called the “declining balance” method. This is essentially where you depreciate the asset by the same percentage every year. Because you’re reducing the value of the asset by a percentage of its value, the amount you’ll end up depreciating will be substantially higher in the earlier years than in the later years. For example, let’s say that you want to depreciate the asset by 20% per year. So in the first year, you subtract 20% from $25,000 to get $20,000. By the seventh year, you’re subtracting 20% from $6553.60 to get $5242.88. By the tenth year you’re getting close to $2,500.

So, why are we calling this the “set it and forget it” decision for new businesses? It’s simple: It’s not good to switch back and forth between the two. It can be tempting to do so if choosing one method one year might give you lower expenses and higher profits and then choosing the other method the next year for the same reason, but you’ll end up with very muddy records that really won’t be very helpful to you.

So, talk to your accountant about which one to choose. The straight line method is really simple to do, so if you like simplicity that might be one to consider. The other method is a little more complicated but businesses like it because it tends to reflect the truer value of an asset during its lifetime (since an asset is usually worth more and provides more value earlier in its lifetime than later).

You have a lot of decisions to make… and this is another one. Fortunately, once you’ve decided, you can move on and focus on other things.