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6. Depreciation and Amortization Projections
Startups typically have very little Depreciation and Amortization because they don’t need factories or retail stores. However, we still need to project this expense, which we will learn how to do in this lesson.
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Lesson Goal (00:04)
The goal of this lesson is to project depreciation and amortization and complete the Income Statement projection.
Depreciating Existing PP&E (00:11)
In order to calculate the Depreciation and Amortization expense, we create a capital expenditure and depreciation schedule, in which we depreciate existing PP&E and future capital expenditure separately.
To depreciate existing PP&E, we obtain a schedule for the percentage of existing PP&E that will be depreciated each year of our projection. We find the amount of existing PP&E in the Balance Sheet, then compute the depreciation expense for each year by multiplying the amount of PP&E by the percentage to be depreciated.
Depreciating New Capital Expenditure (01:25)
In order to depreciate future capital expenditure, we need to know the projected capital expenditure for each future year, and the useful life of this capital expenditure. We calculate the depreciation expense by dividing the capital expenditure amount by the useful life. We calculate the annual depreciation separately for each year’s capital expenditure. We then add the relevant amounts to get the total annual depreciation on new capital expenditure.
Finally, we add the depreciation on existing PP&E and the depreciation on new capex to get the annual depreciation expense. We can also calculate depreciation as a percentage of revenue to sense check our calculations. For example, depreciation as a percentage of revenue falls over time in our model, due to the strong growth in revenue.
Completing the Income Statement Projection (02:23)
After creating the depreciation projection, we can complete the Income Statement projection. After projecting all the operating expenses, we can calculate the projected Earnings Before Interest and Tax, or EBIT, which is gross profit minus operating expenses.
To calculate Profit Before Income tax, we subtract net interest expense from EBIT. Many startups have no debt, and therefore no interest expense. This is because banks are unwilling to give loans to risky startups. If a business has no debt, then Profit Before Income Tax is the same as EBIT.
In this lesson, we're going to project depreciation and capital expenditure for the next five years. When we're calculating depreciation, as you may have seen in previous courses, we're going to project depreciation of existing PP&E separate to depreciation of new CapEx.
To do this, we'll start with existing PP&E. And from TrackerTime, I've already got a schedule of how those assets will depreciate from 2017 to 2021.
I'm going to start by taking the current amount of PP&E on my balance sheet, which is 3.3.
This is relatively high for a startup of TrackerTime's size. Startups typically hold relatively few fixed assets. They don't need big factories to manufacture goods, and they don't need high street stores to sell their products. If they do have high depreciation and CapEx, it's probably due to owning their own office space, which in fact TrackerTime does. So let's now depreciate these assets by taking the total amount, anchoring, and multiplying by the relevant percentage. And I'll copy across for the remaining cells.
Now we need to depreciate future CapEx.
And from TrackerTime, we're told that the useful life of this CapEx will be 10 years. So to depreciate, I'll simply take the amount of CapEx in that year and divide by the useful life.
I'll copy across for the remaining cells.
As I've completed this calculation before multiple times, I'm going to calculate the remaining depreciation on years two to five off camera. To calculate total depreciation, I'll simply add these two figures and copy across.
And to get a sense of what this looks like as a percentage of revenue, I can simply divide by revenue.
Let's now include depreciation in our income statement and complete our income statement. So I'll link my cell to total depreciation and copy across.
And calculate total operating expenses before calculating EBIT, which is equal to gross profit minus total operating expenses.
Because the business has no debt, there will be no net financing costs. And the reason the business has no debt is because at an early stage, banks are unwilling to give the business loans to grow the business.
So the profit before income tax is simply going to be EBIT minus the net financing costs.
The income tax expense I'm going to keep at 35%, so I'll copy across and calculate.
Interestingly, the income tax expense will be zero if we don't declare a profit. To account for this, I'm going to use a max function that will check if zero or the profit before income tax multiplied by the tax rate is greater and then return the greater number.
In the first year, no tax will be paid, but in subsequent years it will be paid as profits grow. And to calculate net profit, I'll simply add these two numbers.
And now our income statement projection is complete.