When a business buys something larger, a machine, a delivery van, new shop fittings, that asset often lasts for many years. So for tax purposes you cannot deduct the full cost in the year of purchase. Instead you spread it over the asset's useful life. That is depreciation.
An example makes it clear: you buy a van for 30,000 EUR with a useful life of six years. You then book 5,000 EUR as an expense each year. After six years the van is fully depreciated on the books, even if it still runs fine. This annual depreciation reduces your taxable profit, and with it your tax bill.
The key point: no real money leaves the business when you depreciate. You already paid for the van. It is purely an accounting entry. That is why depreciation is added back when working out cash flow. The business has more money in the till than the taxed profit suggests. Depreciation is also stripped out of EBITDA to reveal the underlying operating strength.
For a succession, one point matters most. Buy a business as an asset deal and you acquire the individual assets directly. You can then allocate the purchase price to those assets and depreciate them anew. This lowers your taxable profit in the early years, a genuine advantage over a share deal, where you take over the shares and carry on with the old book values.
Anyone taking over or selling a business should keep an eye on depreciation. It tells you how modern the equipment is and whether larger replacement investments are due soon. A look at the asset register is therefore a firm part of due diligence.
For business sellers
Keep your asset register clean and up to date. Which machines and vehicles are not yet fully depreciated, and which have been for years? This gives buyers a clear picture of your asset value.
Many assets already fully depreciated but still in great shape? That is a strong selling point. Bring these hidden reserves actively into your business valuation.
For corporate buyers
Before buying, check how old the equipment is and how much of it has already been depreciated. If an expensive replacement is looming, it belongs on the table during the price negotiation.
An asset deal lets you allocate the purchase price to the acquired assets and depreciate them anew. Factor this tax advantage into your business plan. It noticeably improves your liquidity in the first years.
Example
A joiner takes over a small carpentry workshop for 180,000 EUR in an asset deal. Of that, 60,000 EUR is allocated to machines with a useful life of ten years. She therefore depreciates 6,000 EUR each year. These 6,000 EUR reduce her taxable profit without any money leaving the business. An advantage she can put to good use building up in year one.
FAQ
What exactly does depreciation mean?
Depreciation is the tax and accounting term for spreading the purchase cost of a long-lasting asset over the years it is used, instead of deducting it all at once in the year of purchase.
Why is depreciation added back when calculating cash flow?
Because no real money leaves the business when you depreciate. The asset was already paid for earlier. It only reduces profit on paper. That is why it is added back when working out cash flow, to see how much money actually stays in the till.
How long do you depreciate a machine?
It depends on the useful life set for each type of asset. A vehicle is often depreciated over six years, machines frequently over eight to twelve years, shop fittings over roughly eight years. When in doubt, ask your tax adviser.
Why is depreciation an advantage in an asset deal?
In an asset deal you buy the individual assets directly and can allocate the purchase price to them and depreciate anew. This lowers your taxable profit in the early years, unlike a share deal, where the old book values simply carry on.
What does depreciation tell me about a business I want to buy?
It reveals how modern the equipment is. If many assets are already fully depreciated, replacement investments may be due soon. An important point for due diligence and the later price negotiation.
Buying instead of founding, how does depreciation fit in?
When you buy an existing business, you take over established equipment that you can keep depreciating. Founding from scratch means buying everything first and carrying the full risk. Buying via an asset deal also gives you fresh depreciation as a tax advantage, a solid argument for taking over rather than starting over.
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