It’s estimated that a new car loses about 10% of its value the minute you drive it off the lot, and as much as 20% in the first year of ownership. We have no trouble understanding that the car still has a certain amount of value if we were to sell it or trade it in, and we know that value is less every year. It’s assumed that replacing it with a similar make and model when it reaches the end of its useful life will cost more than what was paid for the original purchase. In that context, the concept of depreciation is clear, but its significance may be harder to grasp when applied to assets like a greens mower or the walk-in freezer in the kitchen at your club.
A prominent CPA firm specializing in auditing private clubs estimates that about 30% of its club clients do not bother to record depreciation expense of fixed assets, electing instead to expense the full cost of the asset in the year it was acquired. The reasons vary; “There is no need because there is no tax benefit.” “We don’t because lenders don’t require it.” And last but not least, the ever-popular “that’s the way we’ve always done it.”
In case you hadn’t guessed, we believe that those clubs should reconsider their approach to depreciation expense, and here’s why.
We’ll start with the obvious... When a club does not account for depreciation expense, its financial statements will not conform to generally accepted accounting principles (GAAP). While it doesn’t seem to do much to change the practice, those clubs will typically see a note about the failure to adhere to GAAP on their audited financials every year.
In addition to the GAAP issue, there are other factors to consider for clubs that do not account for depreciation or for those who consider depreciation a non-cash expense. Without a proper financial accounting of depreciation, a club is essentially blind to the real costs of its capital assets. Depreciation is a real cost. It represents what will become a future cash expenditure. While it may simplify bookkeeping, the practice of dismissing accounting for depreciation is antithetical to proper asset management.
Consider the physical footprint and extensive asset inventory of a private club. It is, without a doubt, a capital-intensive business. Given that the operating ledger of most clubs is set to break-even, club leaders must be conscious of the need to generate enough capital income to overcome the depreciation expense at a bare minimum before funding for aspirational projects can even be considered. The board’s ability to stay focused on all aspects of capital generation ultimately determines the trajectory of the club’s net worth over time and whether a club is generating the capital necessary to meet its future capital needs. The most important financial Key Performance Indicator (KPI) reflecting how well a club is doing at funding its capital needs over time is Net Worth/Members’ Equity. Underfunding obligatory capital negatively impacts the growth of a club’s Net Worth/Members’ Equity.
Management of a club’s long-term cash needs, including replacing existing assets and investing in new (aspirational) assets as dictated by the members and the market, is among the primary obligations of the private club board. Club Benchmarking has long advocated for clubs to develop a comprehensive forward-looking capital plan (we recommend a 10-year horizon) and fund that plan so that capital inflows (operating surpluses, initiation fees, capital fees and assessments) match detailed projections of capital outflows. Those capital outflows include fully funding obligatory capital (replacement costs of existing assets as quantified by a professional reserve study), debt service (including capital leases), implementation of strategic facility and amenity additions (aspirational capital), refunding of membership bonds or fees, etc.
Keeping a private club’s campus fresh and relevant is an important component of retaining and recruiting members. The recognition that depreciation is a real cost that must be funded accordingly is an important consideration for every club’s board.
To learn more about our approach to evaluating and implementing the funding of depreciation and long-term financial planning, please reach out to Joe Abely at firstname.lastname@example.org (781-953-9333) or Dave Duval at email@example.com (617-519-6281).