The Hidden Costs of Depreciation in COGS: Why Procurement Needs to Take Notice

As a procurement professional, you’re well aware of the impact that costs have on your organization’s bottom line. But have you ever considered the hidden costs of depreciation in COGS? Depreciation is often overlooked as an expense that affects businesses’ profitability and competitiveness. In this blog post, we’ll explore what depreciation is and how it impacts businesses. We’ll also uncover the hidden costs of depreciation in COGS and discuss how procurement can take notice to optimize their purchasing decisions. So sit back, relax, and get ready to learn why considering depreciation is crucial for any successful procurement strategy!

What is depreciation?

Depreciation is an accounting practice that reflects the decrease in value of assets over time due to wear and tear, obsolescence or other factors. Assets such as buildings, machinery, equipment, and vehicles lose their value with use and age. Depreciation allocates a portion of the asset’s cost as an expense over its useful life.

There are different methods for calculating depreciation, including straight-line method, declining balance method, sum-of-the-years-digits (SYD) method among others. Each method has its advantages and drawbacks depending on the nature of the asset being depreciated.

Depreciation is not a cash outflow but rather a non-cash expense that lowers net income on the income statement. However, it reduces taxable income and therefore lowers tax liability which can be beneficial for businesses.

While depreciation may seem like a technical accounting concept disconnected from procurement decisions at first glance; it plays an essential role in determining accurate costs associated with producing goods sold by businesses. It impacts COGS and influences pricing strategies used by producers when selling goods to customers

How does depreciation impact businesses?

Depreciation is a significant expense that impacts businesses, particularly those that rely on fixed assets to operate. Depreciation refers to the gradual reduction in value of an asset over time due to wear and tear or obsolescence.

The impact of depreciation can be felt across all areas of a business. For instance, it affects the company’s financial statements, cash flow, taxes and profitability. When an asset depreciates in value, it reduces the book value of the company’s assets which decreases its net worth on its balance sheet.

Furthermore, because depreciation is considered an operating cost for tax purposes, it can reduce taxable income for businesses and result in lower tax payments. However, this also means that companies may have less money available to invest back into their operations as they are paying fewer taxes.

Additionally, when equipment becomes obsolete before fully depreciating or when there is unexpected downtime causing early replacement costs – these hidden costs can add up quickly impacting budgeting decisions and profitability.

In summary, businesses need to take depreciation seriously as it has far-reaching consequences beyond just affecting short-term finances but could even affect long-term sustainability if not managed properly.

The hidden costs of depreciation in COGS

Depreciation can have a significant impact on the cost of goods sold (COGS) for businesses. While COGS typically includes only direct costs such as materials and labor, depreciation represents an indirect cost that is often overlooked.

One hidden cost of depreciation in COGS is its effect on pricing strategy. If a business fails to account for depreciation when setting prices, it may end up undercharging customers and losing out on potential profit margins.

Additionally, depreciation can affect inventory management by reducing the value of assets over time. This reduction in value can result in higher carrying costs for inventory, which ultimately impacts COGS.

Another hidden cost of depreciation is its impact on tax liability. Depreciation expenses are deductible from taxable income, but this deduction decreases the basis of the asset being depreciated. This means that when the asset is eventually sold or disposed of, there may be a higher tax liability due to lower gain or loss recognition.

Procurement teams need to take notice of these hidden costs and incorporate them into their overall purchasing strategies. By factoring in deprecation during supplier negotiations and contract review processes, procurement professionals can ensure that they are accounting for all possible costs associated with procuring goods and services.

Ultimately, taking notice of depreciation’s impact on COGS can lead to more accurate costing models and improved profitability for businesses over time.

How can procurement take notice of depreciation?

Procurement plays a crucial role in managing the costs associated with acquiring goods and services for a business. To effectively manage these costs, procurement professionals need to take notice of depreciation.

Firstly, they can negotiate better prices based on the expected lifespan of equipment and machinery. By factoring in depreciation, procurement can ensure that purchasing decisions are made with long-term value in mind rather than just upfront cost savings.

Secondly, procurement can collaborate with finance teams to accurately track depreciation expenses and forecast future expenditures. This allows them to plan ahead for equipment replacements or upgrades before they become a financial burden on the company.

Thirdly, by tracking asset lifecycles through proper maintenance schedules and repairs, procurement can maximize their value while minimizing their impact on COGS. Procurement should also consider end-of-life disposal or resale options to recoup some of the initial investment.

In summary, taking notice of depreciation is essential for effective procurement management. It enables businesses to make informed purchasing decisions that balance short-term cost savings with long-term value creation strategies.

Conclusion

To sum up, depreciation is an essential aspect of any business that affects the COGS and ultimately determines the profits or losses at the end of a financial period. Procurement teams have a crucial role to play in managing depreciation costs by ensuring timely maintenance, repairs, and replacements of assets.

By taking notice of depreciation in COGS, procurement teams can make informed decisions about purchasing new assets or leasing them instead. They can also negotiate better prices with suppliers when they have accurate data on asset lifecycles and expected depreciation rates.

In today’s competitive market, businesses cannot afford to ignore hidden costs like depreciation. By working closely with finance departments and leveraging technology solutions such as asset management software, procurement professionals can help their organizations stay ahead of the curve while minimizing expenses associated with depreciating assets.