Depreciation: Owner’s Financial Statement vs. Recast
Depreciation: Owner’s Financial Statement vs. Recast (Economic) Financial Statement
Depreciation appears on both an owner’s financial statement and a recast (economic) financial statement, but its purpose and impact differ depending on the context.
1. Depreciation on the Owner’s Financial Statement
Goal: Minimize Taxable Income
For the business owner, depreciation is primarily a tax strategy. The goal is to:
✔ Reduce taxable income by spreading asset costs over time.
✔ Follow IRS guidelines (e.g., MACRS depreciation).
✔ Report lower net profits, which helps minimize tax liability.
In many cases, depreciation on the financial statements does not reflect the real economic impact of asset wear and tear—it’s simply an accounting tool used to comply with tax regulations.
2. Depreciation on a Recast (Economic) Financial Statement
Goal: Show the Business’s True Profitability
When selling a business, depreciation is adjusted or recast to show the company’s actual earning power. The goal is to:
✔ Normalize financials so buyers can see true discretionary earnings.
✔ Remove non-cash expenses like depreciation to determine Seller’s Discretionary Earnings (SDE) or EBITDA.
✔ Help buyers understand whether assets will need replacement soon, impacting future cash flow.
Example of Recasting Depreciation
• Owner’s Tax Financials: Depreciation expense is $100,000, reducing taxable income.
• Recast Financials for Sale: Since depreciation is a non-cash expense, it is added back to reflect higher earnings(unless assets need replacement soon).
Key Takeaways
|
Factor |
Owner’s Financial Statement |
Recast (Economic) Financial Statement |
|---|---|---|
|
Purpose |
Reduce taxable income |
Show true business earnings (SDE/EBITDA) |
|
Accounting Method |
IRS rules (MACRS, Straight-line, etc.) |
Adjusted to reflect economic reality |
|
Impact on Profitability |
Lowers net income for tax savings |
Increases earnings to attract buyers |
|
Effect on Business Value |
May make the business look less profitable |
Helps justify a higher selling price |
When preparing to sell my business, working with a business broker to properly recast financials is critical. Understanding depreciation from both perspectives ensures you present your business in the best possible light to potential buyers.
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