## Depreciation: What Investors Need to Know

When it comes to financial statement analysis, the term **depreciation** is a key concept that investors must understand. It’s not just an accounting term but an essential tool for genuinely assessing the quality of a business.

### What is depreciation (Depreciation)? Simply put,

Depreciation refers to the process by which the value of fixed assets (such as machinery, buildings, vehicles) decreases over time. Accounting records this reduction as an expense to reflect wear and tear and actual usage of the assets.

There are two perspectives to understanding depreciation:
- **Physical perspective**: Fixed assets naturally deteriorate and lose value over time.
- **Accounting perspective**: Allocating the initial cost of assets across their useful life.

Example: A company purchases a computer for 50,000 THB, expected to be used for 5 years. The depreciation expense will be approximately 10,000 THB per year.

### Why is depreciation important to investors?

Depreciation significantly impacts net profit and EBIT. When reviewing financial statements, this expense is deducted from revenue, reducing net profit.

**Important**: EBIT (Earnings Before Interest and Taxes) does not include interest and taxes but **includes** depreciation. EBITDA adds back depreciation and amortization.

Reasons why investors should care:
- Businesses with many fixed assets (such as hotels, oil refineries) tend to have high depreciation, resulting in lower net profit.
- Understanding EBIT and EBITDA helps compare companies across industries fairly.

### Which assets can be depreciated?

**Assets eligible for depreciation:**
- Vehicles, buildings, infrastructure
- Machinery and industrial equipment
- Office equipment, furniture, computers
- Intangible assets (patents, copyrights, software)

**Assets not eligible for depreciation:**
- Land (considered to have an indefinite lifespan)
- Collectibles (art, coins)
- Investments (stocks, bonds)
- Personal property

### Four main methods to calculate depreciation

#### 1. Straight-line Method(
The simplest and most commonly used method, dividing the asset’s cost evenly over its useful life.

**Formula**: )Initial cost - salvage value( ÷ useful life

**Advantages**: Easy to understand, reduces errors, suitable for most businesses.

**Disadvantages**: Does not reflect faster loss of value in the early years; does not account for increasing maintenance costs over time.

)# 2. Double Declining Balance###
An accelerated method that results in higher depreciation in the first year and decreasing thereafter.

**Advantages**: Helps offset higher maintenance costs in later years; maximizes initial tax deductions.

**Disadvantages**: More complex; less suitable for small businesses.

(# 3. Declining Balance Method)
A moderate accelerated method where the asset’s book value is depreciated at twice the straight-line rate.

Advantages: Balances simplicity and accuracy.

#### 4. Units of Production(
Depreciates based on the number of units produced or hours used.

**Example**: A factory machine expected to produce 1 million units over its lifespan. If it produces 100,000 units this year, depreciation = 10% of cost.

**Advantages**: Accurate for assets with variable usage.

**Disadvantages**: Difficult to track in real life.

) What is amortization?###

Amortization is similar to depreciation but applies to:
- **Intangible assets**: copyrights, patents, company reputation
- **Loans and debts**: loan repayments made in installments, including interest and principal

**Example**: A company acquires a patent worth 10,000 THB, valid for 10 years. Amortization = 1,000 THB per year.

( Main differences between Depreciation and Amortization

| Criterion | Depreciation | Amortization |
|------|--------------|--------------|
| **Assets** | Tangible )buildings, machinery### | Intangible (copyrights, patents) |
| **Calculation method** | Straight-line or accelerated | Straight-line only |
| **Salvage value** | Considered | Not considered |

### Impact on financial analysis

When analyzing EBIT and EBITDA, remember:

**EBIT** = Net income + interest + taxes (depreciation included)

**EBITDA** = EBIT + depreciation + amortization

Businesses with heavy assets (such as fixed assets) tend to have high depreciation, which lowers EBIT. However, EBITDA may appear more favorable. The main role of EBITDA is to provide a clear picture of earning capacity before considering capital structure ###interest, taxes(, and capital investments.

) Application in investing

Smart investors will:
1. Review the company's depreciation policy, as it can affect reported profits.
2. Compare EBITDA across companies with different asset structures.
3. Adjust profits to reflect the true financial situation.

Understanding depreciation means grasping key concepts in financial statement analysis, helping you make better investment decisions.