Making Sense of the “Invisible” Expenses: Depreciation and Amortization
Have you ever looked at a business income statement and wondered how a company can claim an expense without actually spending any cash that month? It sounds like magic, but it is actually a standard part of business called Depreciation and Amortization.
These terms might sound like “accountant-speak,” but they are actually simple ways to track the value of what your business owns over time. Let’s break them down.
What is Depreciation?
Depreciation is a necessary expense on your income statement, but it is unique because it does not affect your cash flow.
When a business buys a “capital asset,” something with a high dollar value that stays useful for a long time, like a car, a machine, or a computer, we don’t record the entire cost the moment we buy it. Instead, we put it on the balance sheet and recognize that expense slowly over time.
How it works in real life: Imagine your business buys a car. If that car is expected to be useful for four years (48 months), you don’t take the hit all at once. Instead, you “chop” that purchase price into 48 equal monthly depreciation expenses. This allows the business to recognize the cost over the entire time the car is actually helping you do work.
What is Amortization?
Amortization works very similarly to depreciation, but it applies to a different category of items: Intangible Assets.
An intangible asset is something your business owns that doesn’t have a physical existence. You can’t touch it, but it still has major value. Common examples include:
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Trademarks
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Websites
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Patents or intellectual property
Just like depreciation, amortization hits your income statement as an expense, but it does not take a single cent out of your cash reserves at that moment.
The Math Breakdown: If you buy a trademark and decide it will be useful for 10 years (which is 120 months), you simply divide that purchase price by 120. That smaller amount becomes your monthly amortization expense.
The Bottom Line
Whether you are dealing with a physical truck (Depreciation) or a digital website (Amortization), the goal is the same: to match the cost of the item to the period of time it is actually serving your business.
Understanding these “invisible” expenses helps you see the true health of your business beyond just the balance in your bank account.