how to calculate depreciation on a car
Depreciation
Depreciation is the process of a car decreasing in value over time due to wear and tear. As your car ages and adds miles to the odometer, it progressively decreases in value. Understanding depreciation is important to knowing the value of your car in the future. It can be overlooked, but in many cases it is the largest opportunity cost of owning a car. Different cars have different depreciation rates; in general, new cars depreciate 23.5% of their value in the first year, and can depreciate 60% of their retail value within the first three to five years. After this point, the rate of depreciation begins to slow down. Used cars do not depreciate at as high of a rate as new cars, so keep that in mind when you are in the market for a vehicle. Sports cars tend to depreciate rather quickly because they typically need more expensive maintenance more often and can be driven aggressively. A vehicle like a truck, however, tends to do a better job holding its value because they are required to do work as part of their job. Luxury cars also tend to retain value since they have high demand even when used, making them more affordable and desirable. When buying a car, there are many factors to consider, like safety, style, economy, and price. However, depreciation should also be a primary focus when determining which car to purchase.
Salvage Value
When considering depreciation, also consider the salvage value, or the asset’s estimated value at the end of its life time. If you know the salvage value of an asset, you can use the cost of the asset to subtract the salvage value to find the total amount that is able to be depreciated. If the asset has no salvage value, the cost of the asset will be equivalent to the total depreciation.
Methods of Calculating Depreciation
There are several different methods of calculating depreciation. Keep in mind that regardless of the method used, the depreciation value will remain the same for all the methods, however the timing of depreciation will be altered. For calculating the depreciation of cars, there are two primary methods: the Straight Line method, and the Declining Balance Depreciation method.
The first method of depreciation is the Straight Line method. This is the most commonly known method and one of the simplest as well. With the Straight Line method, you can distribute the cost of a car evenly across its useful life. Here is the formula for this depreciation calculation method:
Depreciation per year = (Asset Cost - Salvage Value) / Useful Life
The newer a car is, the quicker it depreciates. However, as the car ages, its depreciation rate gradually slows down. If you are considering buying a new car, using the Declining Balance Depreciation method is preferable because it tends to be more accurate at reflecting book value from year to year than the Straight Line method. Here is the formula for the Declining Balance Depreciation method:
Depreciation per year = Book Value * Depreciation Rate
Conclusion
Depreciation is a very important factor to consider when looking for the right car. It can vary greatly depending on the type of car, condition, price, and other factors. Using the two methods described above, the Straight Line and Declining Balance Depreciation method, you can accurately calculate your vehicle’s estimated depreciation. Understanding how depreciation will affect your vehicle’s value after a few years will ensure you are buying smart and avoiding losing out on money when trying to trade in or sell. A car’s depreciation can often be overlooked, however in reality it can be the biggest cost of owning a car.
