What impact does depreciation have on a company's profitability?

Depreciation reduces a company's profitability by decreasing its net income.

Depreciation is an accounting method that allocates the cost of a tangible or physical asset over its useful life or life expectancy. It is a non-cash expense that reduces the value of the asset as it ages, becomes obsolete, or gets used. This reduction in value is reflected in the company's income statement as an expense, which in turn reduces the company's net income and thus its profitability.

For example, if a company purchases a machine for £100,000 with a useful life of 10 years, it might depreciate the machine at £10,000 per year. This means that each year, the company's income statement will show a depreciation expense of £10,000, reducing its net income by that amount. Over the 10-year life of the machine, the company will have reduced its net income by a total of £100,000.

However, it's important to note that depreciation is a non-cash expense. This means it doesn't involve an actual outflow of cash from the company. Instead, it's an accounting practice that allows companies to better match the cost of an asset to the revenues it generates. This can provide a more accurate picture of a company's financial health and performance.

While depreciation reduces profitability, it also provides a tax advantage. Since it's considered an operating expense, it reduces the company's taxable income, which can lead to lower tax payments. This can partially offset the impact of depreciation on a company's profitability.

In summary, depreciation impacts a company's profitability by reducing its net income. However, it also provides a more accurate reflection of the company's financial performance and can offer tax advantages.