What does depreciation refer to in the context of business assets?

Depreciation refers specifically to the decrease in value of a business asset over time due to factors such as wear and tear or obsolescence. This economic concept is crucial for businesses as it reflects the reality that physical assets, like machinery or vehicles, lose value as they are used and age.

Understanding depreciation is key in accounting and financial reporting, as it impacts profit and asset valuation. Businesses often apply depreciation methods to account for this decline in value on their financial statements, affecting tax deductions and investment decisions. By correctly applying depreciation principles, a business can better manage its cash flow and make informed decisions regarding asset replacement or upgrades. This allows for a more accurate assessment of an asset's value, ensuring the financial statements provide a true representation of the company's financial health.