Depreciation

Depreciation is an accounting mechanism that spreads the cost of a tangible asset (such as machinery, vehicles, or equipment) over its expected useful life rather than recognising the full cost in the year of purchase. Common depreciation methods include straight-line (equal annual charge over the asset's life) and reducing balance (a fixed percentage applied to the reducing book value each year).

For lenders, depreciation matters in two ways. First, it reduces reported profit - EBITDA (earnings before interest, tax, depreciation, and amortisation) adds back depreciation to give a clearer picture of cash-generative profitability. Second, it affects the book value of assets on the balance sheet, which determines how much can be borrowed against them.

For asset finance decisions, the depreciation profile of an asset affects the lender's residual value calculations. Assets that depreciate slowly (commercial property, agricultural land) support longer-term and higher-LTV lending. Assets that depreciate rapidly (IT equipment, specialist machinery) may attract lower advance rates or shorter maximum terms.

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