Connect with us

Finance & Accounting

What Is Depreciation?

Published

on

Depreciation is a calculation used to reduce the value of a fixed asset over a period of multiple years. Many small-business owners find this concept confusing because depreciation does not match cash flow. Instead, it is a calculation made and an entry recorded into the bookkeeping on a recurring basis.

Fixed assets lose their usefulness and value over time. This loss usually doesn’t coincide with when the purchase is made, even if the purchase is made over time by making installment payments. Like accrual basis accounting, depreciation matches expenses to a given time period, but it isn’t strictly an accrual basis concept. This calculation will appear on both cash basis and accrual basis financial statements.

Depreciation formula

The different depreciation formulas are:

Straight-line depreciation formula:

(Cost of asset – Scrap value of asset) / Useful life of asset = Depreciation expense

Units of production depreciation formula:

(Number of units produced / Life of asset in units) x (Cost of asset – Scrap value of asset) = Depreciation expense

Double declining balance depreciation formula:

100% / Life of asset = Depreciation rate

Sum of the years’ digits depreciation formula:

(Remaining life of the asset / Sum of the years digits) x (Cost of asset – Scrap value of asset) = Depreciation expense

With these formulas in mind, let’s take a closer look at each depreciation method and when you might want to use each.

Depreciation methods and examples

There are four common methods of depreciation used in accounting. These accounting methods differ from the depreciation schedules used for taxes. They are still important to know in order to determine how to make this calculation from a managerial perspective.

1. Straight-line depreciation

The most common method is called straight-line depreciation. It is also the simplest method. With straight-line depreciation, you subtract the estimated salvage or scrap value of the asset at the end of its useful life from the cost of the asset, then divide that value by the useful life of the asset. In other words:

(Cost of asset – Scrap value of asset) / Useful life of asset = Depreciation expense

Example: Let’s say you purchase a piece of equipment for $260,000. You anticipate using the equipment for eight years, and you anticipate the scrap value will be $20,000. The calculation for depreciation of the vehicle under the straight-line method would be:

($260,000 – $20,000) / 8 = $30,000

In order to not skew your end-of-year financial statements, you want to make the depreciation entry each month:

$30,000 / 12 months = $2,500/month

Each month of the year, you would make the following journal entry:

Debit: Depreciation expense $2,500

Credit: Accumulated depreciation: Equipment $2,500

This will reduce your net income by $2,500 each month, and it will also offset the value of the asset on your balance sheet by $2,500 each month.

Note that you’re not crediting the actual asset account on the balance sheet, but a separate account called “accumulated depreciation.” The accumulated depreciation account will have a negative balance, which offsets the value of the asset without changing it on the balance sheet. You will often see these accounts as sub-accounts of the different types of fixed asset accounts on the balance sheet.

2. Units of production depreciation

The units of production depreciation method is similar to the straight-line method in that it is simple to calculate. Units of production depreciation is most often used for equipment that is expected to produce a certain number of items before it is no longer useful.

The formula for units of production depreciation is:

(Number of units produced / Life of asset in units) x (Cost of asset – Scrap value of asset) = Depreciation expense

Example: Let’s say the equipment you purchased in the example for straight-line depreciation is a machine you will use to manufacture whatsits. The machine is expected to produce 120,000 whatsits before it is no longer useful. You pay $260,000 for the machine, and the scrap value is estimated to be $20,000.

Each year, you will determine how many units the machine produces. Let’s assume in year one the machine produces 2,000 whatsits, in year two it produces 4,000 and in year three it produces 8,000:

Year 1: (2,000 / 120,000) x ($260,000 – $20,000) = $4,000

Year 2: (4,000 / 120,000) x ($260,000 – $20,000) = $8,000

Year 3: (8,000 / 120,000) x ($260,000 – $20,000) = $16,000

You will continue this calculation yearly until the machine reaches its production capacity of 120,000 whatsits.

As with the straight-line method, you will want to divide the depreciation expense by 12 and record it each month so you don’t skew your financials in the last month of the fiscal year.

3. Double declining balance depreciation

Double declining balance depreciation is an accelerated depreciation method. Accelerated methods are used when you are dealing with assets that are more productive in their early years. The double declining balance method is often used for equipment when the units of production method is not used.

The calculations for accelerated methods are a bit more complex than those for straight-line or units of production methods, and so usually business owners using accelerated methods will set up a depreciation schedule — a table that shows the depreciation expense for each year of the asset’s life — so they only have to do the calculations once.

Example: Let’s say you don’t know how many units your whatsit manufacturing machine can produce, but you know it’s likely to last eight years. First, you’ll need to calculate the rate of depreciation:

100% / Life of asset = Depreciation rate

100% / 8 = 12.5%

You’ll multiply the depreciation rate above by two because you are doubling the rate of depreciation:

12.5% x 2 = 25%

Once you have your depreciation rate, will multiply that rate by the beginning value of the asset to get the depreciation expense for the first year:

Beginning value of asset x Depreciation rate = Depreciation expense

$260,000 x 25% = $65,000

Finally, you need to calculate the value of the asset at the end of year one:

$260,000 (beginning value of asset) – $65,000 (depreciation expense) = $195,000

The depreciation calculation for year two follows the same formula, except now your beginning asset value is $195,000:

$195,000 x 25% = $48,750

And the ending value for year two is calculated:

$195,000 – $48,750 = $146,250

You will continue with these calculations until you reach the scrap value of the asset.

4. Sum of the years’ digits depreciation

Like double declining depreciation, sum of the years’ digits depreciation is an accelerated method. The formula is:

(Remaining life of the asset / Sum of the years digits) x (Cost of asset – Scrap value of asset)* = Depreciation expense

*The second part of this equation is the depreciation base

Example: Let’s stick with our whatsit machine for this example. First, let’s calculate our depreciation base:

Cost of asset – Scrap value of asset = Depreciation base

$260,000 – $20,000 = $240,000

Next, you’ll need to determine the “remaining life of the asset/sum of the years’ digits” piece of the calculation. The remaining life is just as it sounds: It’s the remaining life of the asset. For this example, in year one the remaining life will be eight years, in year two it will be seven years, and so on. The tricky bit of this equation is the “sum of the years’ digits” piece.

Here’s how the calculation would look in year one:

8 (remaining life) / (8+7+6+5+4+3+2+1) (sum of the years’ digits) = 0.222

And now you multiply this factor by the depreciation base:

0.222 x $240,000 = $53,280

Our year one depreciation expense is $53,280. In year two, our calculation would look like this:

7 (remaining life) / (8+7+6+5+4+3+2+1) (sum of the years’ digits) = 0.194

0.194 x $240,000 = $46,560

And our year three calculation would be:

6 / (8+7+6+5+4+3+2+1) = 0.167

0.167 x $240,000 = $40,080

You will continue with these calculations until there is no remaining life of the asset and you reach the asset’s scrap value.

Depreciation for taxes

The four methods above are used for managerial and business valuation purposes. And although it’s important to understand these methods, many small-business owners will only record depreciation as it is calculated by their accountants for the tax return. This ensures the balance sheet matches the tax return, which in turn makes it easier to validate the accuracy of the financial statements.

Tax depreciation is different from depreciation recorded for managerial purposes. Tax depreciation follows a system called MACRS, which stands for modified accelerated cost recovery system. MACRS is a form of accelerated depreciation, and the IRS publishes tables for each type of property. You can learn more about MACRS depreciation and review the tables on the IRS’s website.

Using depreciation to manage cash requirements

One often-overlooked benefit of properly recognizing depreciation in your financial statements is that you can use this calculation to plan for and manage your business’s cash requirements. This is especially helpful if you want your business to fund the acquisition of future assets rather than taking out a loan to acquire them.

Let’s look back at our very first example. Because we’ve taken the time to determine the useful life of our equipment for depreciation purposes, we can make an educated assumption that the business will need to purchase a new piece of equipment within the next eight years. The earlier we can start planning for that purchase — perhaps by setting aside $2,500 per month in a business savings account — the easier it will be to fund the replacement of the equipment when the time comes.

A version of this article was first published on Fundera, a subsidiary of NerdWallet

Advertisement

This post was originally published on this site

Continue Reading

Finance & Accounting

Accounts Payable and Your Business: What You Need to Know

Published

on

Accounts payable covers all of your business’s values. They include the charges and other debts that the company needs to pay. The only thing that a business delivers that is not recognized accounts payable is payroll. Everything else falls under this category, making it a critical phase of your business. Here’s how to handle it.

The accuracy and the overall completeness of a company’s financial records are dependent on the reports payable process. The power and effectiveness of the account’s due process will also affect the company’s cash situation, credit rating, and overall relationship with its suppliers.

Implementing a reliable accounts payable system will provide accurate financial data you need to plan for both the short and long term. Here’s what you simply need to know about putting up with your business accounts.

Examples of Accounts Payable

These are some parts of accounts payable:

  • Cleaning services: One example of records payable is when a company chooses an outside company to manage its cleaning services. In this case, the business must send regular statements to the company in the market for prompt and reliable assistance.
  • Staff uniforms: Another example of accounts due is when a company hires a different company to create its clothes. In this case, many businesses have to constantly order uniforms for new employees and return or compensate for the uniforms that have been destroyed by existing employees.
  • Office supplies: Another striking example of accounts due is that of office supplies. Many businesses buy office supplies in size and have automatic systems set up based on the rate at which these supplies are simply used. Therefore, they often have pending payments to these stationeries to ensure efficient workflow.
  • Sanitation: Lastly, many companies must pay to have their trash and recyclables hauled away. These services are typically weekly. 

Tracking Accounts Payable

Accounts payable, seldom abbreviated as A/P, are tracked regularly for many small companies. Still, as the business grows, it is better to make it a weekly task to take account of early payment interests and choose any credits due to inventory records. It is very handy to keep a record of payable if there are any payment disputes, to tell the business about current or outstanding invoices, or to use as proof of spending at tax time. These documents can be kept manually or with accounting software. 

Working with accounts payable needs excellent attention to detail. Each invoice must be checked for accuracy, billing date, and return date and then entered accurately in the general ledger or accounting software. Based on the research, here are some common tips for setting up your accounts payable and help the method run smoothly:

  • Work from the original invoice whenever possible. Some invoices are sent electronically. To avoid any mistakes in electronic statements, print the invoice once and then file the email to reduce confusion.
  • Get invoice approval from the most appropriate person before entering it. The person signing the invoice should be different than the one entering it. If you are a sole proprietor and do your bookwork yourself, this may not be possible, but you still have an explicit approval and entry process. Keep solid records to help each one. 

Envolta for Help

Cash flow is vital to a small business. A solid monitoring and paying accounts due system gives you an explicit knowledge of your costs against your revenue, allowing better business choices. 

When you know where all of your business is going, your business can thrive! Allow Envolta, the expert auditors and accountants, to provide a detailed picture of your companies’ liabilities and costs that accrue as they handle your accounts payable. As your very own records payable department, they will allocate and track your income, on your behalf, in a couple of various areas.

This post was originally published on this site

Continue Reading

Finance & Accounting

What Is the Easiest AmEx Business Card to Get?

Published

on

There are a number of American Express business credit cards that come with rewards and perks designed to benefit business owners. That leaves many applicants wondering what the easiest AmEx business credit card to get might be. What constitutes the easiest AmEx business card, however, is complicated.

Every AmEx business credit card requires certain basics from applicants, including strong personal credit (typically a FICO score of at least 690), as well as business revenue and liquidity (if your company is established enough to have these).

Because the qualifications across these cards are similar, there isn’t necessarily an AmEx business card that’s any easier to obtain than any other. But that doesn’t mean you should blindly pick among the offerings, particularly if you’re just starting your business. Read on for more details on the factors you should consider when choosing an American Express business card, and compare the offers near the bottom to find the best card for your business needs.

Good to excellent credit is a must

American Express doesn’t specifically spell out its credit score requirements for business cards, but applicants should have good to excellent credit, with scores ranging from 690 to 850.

Your personal finances play a large role in whether or not you can get a business credit card. New businesses may not have enough credit history on their own to help issuers determine their creditworthiness, so a personal credit history helps fill in the gaps. If your personal credit score is low, you may have a hard time getting a card for your business.

If you’re below the average American Express credit score, rejection isn’t necessarily guaranteed. Other factors, such as personal income, can have an impact. The same goes for your business credit history, annual revenue and cash reserves.

Look at rewards, fees and purchase flexibility

Since American Express business cards usually require the same credit score range, finding the easiest AmEx business card to get is likely to end up being a draw. Instead, consider the advantages each card provides, such as rewards, fees and purchasing power. These are areas where American Express business cards tend to differ the most.

For instance, if you travel frequently, you may want to consider a card that rewards you with airline miles or hotel perks. If you’re more concerned with keeping costs low and are fine with flat-rate rewards, having a card with an introductory 0% annual percentage rate and no annual fee could be a strong option. Should you want the ability to buy above your credit limit, a card that emphasizes purchase flexibility might be a good choice.

Top American Express Business Cards

The Blue Business® Plus Credit Card from American Express

Our pick for: Introductory APR and $0 annual fee

This card offers 1x to 2x points on everyday business purchases. You can get 2x points for the first $50,000 in purchases every year; after that, you’ll receive 1x points for all additional purchases. Terms apply. The flexibility that comes with points-eligible purchases makes this a good card for business owners who want a broad range of opportunities to earn points, while the $0 annual fee makes it an easier card to get for business owners who want to keep extraneous expenses down.

American Express® Business Gold Card

Our pick for: Customizable rewards

Not every business has the same kind of expenses. That’s why the American Express® Business Gold Card offers six bonus categories that can earn you rewards for everyday spending. Better still, this card automatically earns 4x points for your two most commonly used categories every month (up to the first $150,000 in combined purchases).

Earn 70,000 Membership Rewards® points after you spend $10,000 on eligible purchases with the Business Gold Card within the first 3 months of Card Membership. Terms Apply. This is in addition to the 4x points you can get from two categories each calendar year (up to the $150,000 limit).

The annual fee on the American Express® Business Gold Card comes in at $295, which means you should consider how often you plan to use the card before applying. But if you expect to use a business card often, this option might be a good fit.

The Plum Card® from American Express

Our pick for: Flexible financing

Many businesses require a large amount of working capital but may not have consistent cash flow to match. The Plum Card® from American Express can help you with flexible spending: You can take up to 60 days to pay your balance without interest when paying the minimum due by the payment due date. If you pay the bill within 10 days of the statement closing date, there’s a 1.5% early pay discount. Terms apply.

Additionally, this card has no preset spending limit; the amount you can spend adapts based on factors such as your purchase, payment and credit history. Terms apply.

The Plum Card® from American Express also comes with an annual fee of $0 intro for the first year, then $250. There are no foreign transaction fees with this card either, which can come in handy if you need to use it overseas.

Marriott Bonvoy Business™ American Express® Card

Our pick for: Hotel rewards

If you travel often, the Marriott Bonvoy Business™ American Express® Card can help you make the most of your business expenses with Marriott hotel rewards. You’ll get rewarded for everyday business purchases as well as eligible purchases at participating Marriott Bonvoy hotels.

Earn 75,000 bonus Marriott Bonvoy points after you use your new Card to make $3,000 of eligible purchases within the first 3 months of Card Membership. Plus, earn up to $150 back in statement credits on eligible purchases made on your new Card within the first 3 months of Card Membership. Terms Apply. Better still, you’ll get 6x points on eligible purchases at Marriott Bonvoy hotels and 4x points at U.S. restaurants, gas stations, wireless telephone services and shipping purchases. You’ll get 2x points on all other eligible purchases as well. Terms apply.

To view rates and fees of The Blue Business® Plus Credit Card from American Express, see this page.

To view rates and fees of the American Express® Business Gold Card, see this page.

To view rates and fees of The Plum Card® from American Express, see this page.

To view rates and fees of the Marriott Bonvoy Business™ American Express® Card, see this page.

Advertisement

This post was originally published on this site

Continue Reading

Finance & Accounting

Can You Get a Business Credit Card Without Providing a Social Security Number?

Published

on

Getting a business credit card is a crucial step in the process of separating personal and business finances. But if you’re a non-citizen who doesn’t have a Social Security number or you’re hoping to keep your personal credit out of your business finances, you may be looking to get a business credit card without providing a Social Security number.

However, it’s not common to get a business credit card without providing your Social Security number. In most cases, you’ll need to not only provide a Social Security number but also a personal guarantee that you’ll pay the charges personally in the event that your business can’t.

Why business credit card applications ask for your Social Security number

Credit history

When you apply for a personal credit card, a lender looks at your credit score and history to determine if you’re likely to pay bills on time. The same is true for business credit cards, although it’s much less likely that a new business has enough of a credit history to help lenders make this determination.

That’s where your personal credit plays a factor. In the absence of your business’s credit history, banks will look at your personal credit score and track record of paying off debts. Your personal credit history helps lenders infer how you’ll handle your business’s debts, which helps them determine your eligibility.

Business identification

If you don’t have an employer identification number on file with the IRS, your Social Security number may also be used to identify your company on a business credit card application. Even if you do have an EIN, most business credit card providers will still want your Social Security number so they can run a personal credit report. Most business credit card issuers require good to excellent credit — usually a FICO score of 690 or higher.

Personal guarantee

Additionally, since the majority of business credit cards require a personal guarantee from the cardholder, a Social Security number is needed for this as well. This guarantee reduces the amount of risk a credit card issuer takes on, which makes it easier for small businesses to get credit.

How to apply for a business credit card without a Social Security number

Provide other collateral

The vast majority of business credit cards require applicants to provide their Social Security number at some point in the process. However, there are a few kinds that don’t. Qualifying for these cards usually means having large cash reserves and significant business revenue. This signals to creditors that your business is on solid financial footing and better able to pay off your credit card bill. Small and medium-sized businesses that don’t have ample cash on hand or large revenue figures are less likely to get approved for these cards.

Even if you do qualify for a business credit card without providing a Social Security number, you may still need to offer collateral or sign a uniform commercial code, or UCC, lien. Both offer a guarantee to the credit card issuer that they will get some amount of debt paid back to them if your business can’t afford its bills.

Obtain an ITIN and EIN

If you don’t have a Social Security number to provide, you can still apply for a business credit card. First, you’ll need to file for an individual taxpayer identification number, or ITIN. The IRS issues these to foreign nationals who need taxpayer identification but aren’t eligible for a Social Security number.

Once you have an ITIN, file for an EIN. An EIN serves as a kind of Social Security number for your business. You can apply for an EIN through the IRS’ website for free, and creditors can look into your existing business credit history with this number as well.

Business credit cards that don’t require a Social Security number

There are very few business credit cards that don’t require a Social Security number or EIN. One option, the Brex Card, is a corporate card that doesn’t require applicants to provide their Social Security number or a personal guarantee. With the Brex Card, your business’s cash flow and spending patterns help dictate your creditworthiness. You’ll also need to keep a bank balance of $100,000 to qualify.

Several retail business credit cards are more flexible about Social Security numbers and, more importantly, requiring a personal guarantee. Several big-box stores, office supply stores and gas stations offer cards that may not require a personal guarantee as long as your business meets certain criteria.

Advertisement

This post was originally published on this site

Continue Reading

Trending

SmallBiz Newsletter

Join our newsletter for the latest information, news and products that are vital to running a successful SmallBiz.