Depreciation and amortization are two important accounting terms that help to provide financial insight and clarity on a business’s current financial position.
Both of these terms recognise that the business has incurred an expense and, as such, this should be recorded. However, the expense comes without the associated cash flow; i.e., these are recorded as non-cash flow transactions.
Of course we understand that cash flow is vital for business, and ensuring that late payment of invoices is avoided and money is received when expected is vital to keep finances healthy.
At Direct Route, we work with credit teams and commercial businesses to collect outstanding invoices and late payments. We help support positive cash flow and ensure that businesses get paid on time, every time.
This post looks at depreciation and amortization further and the benefits of each.
Depreciation vs amortization
Before we look at depreciation and amortization differences, let’s first start by looking at the definition of both of these terms.
Amortization
Amortization focuses on the intangible assets a company holds, i.e., those that aren’t physical pieces of equipment, but still have value.
In this instance, amortization is the process of spreading the cost of the intangible asset in question over the course of its life, which is noted on accounting records, i.e., amortization is the method of decreasing an asset’s cost over time.
Intangible assets include:
- Franchise agreements
- Trademarks
- Copyrights
- Patents
- Software
- Digital assets
- Intellectual property
- And more.
Why is amortization important?
Amortization provides a detailed insight into a company’s financial performance, specifically relating to the expenses incurred from using and maintaining intangible assets.
Calculations for amortization for accounting purposes include:
Straight line method – here, a reduction of the asset is carried out every year, until the end of its lifespan, i.e., it is a straight-line basis where the same amount is expensed every year.
Depreciation
Depreciation relates to physical, tangible assets and allocates the cost of the asset over time.
Ultimately, depreciation represents how much value the asset loses over a specific period.
This loss of value could be due to general wear and tear, aging, etc.
Physical, tangible assets can include:
- Company equipment
- Property
- Vehicles
- Hardware
- And more.
When making depreciation calculations for accounting, it’s important that you know the exact cost of the asset and then the decline in value, i.e., the reduction in the book value of the asset. This is needed for tax calculations.
The most popular calculation for depreciating assets is the accelerated depreciation method, which uses the double declining balance system.
Declining balance method – this accounting practice sees an acceleration of the value amount, the expense of a fixed asset over its life. In this calculation, you can subtract the asset’s resale value from the original cost, with this cost spread out over the predicted life of the asset, with a portion of the cost being noted as an expense every year.
Difference between depreciation and amortization
- They focus on different types of assets – depreciation is for physical assets; amortization is for intangible assets.
- The calculation methods for both are slightly different, with more calculation options available for depreciation, making it also slightly more complex. For example, you can accelerate depreciation where depreciation expense is recognised earlier in the asset’s life, compared to amortization, where the expense is the same amount at all times.
- There is a variance between the two on the impact on finances. For example, amortization spreads the cost of the asset over time, whereas depreciation helps a company to recover the actual item’s expense over time as its value gradually decreases.
- Depreciating assets hold a salvage value, whereas intangible assets do not, i.e., you can salvage some value from a depreciating physical asset.
- Amortization spreads the cost of the asset over a period of time, whereas depreciation reduces its value.
- Physical assets have a much shorter life span than intangible assets, and this will affect your financial outlook and, hence, planning.
Both amortization vs depreciation:
- Help with costs and profitability.
- Provide visibility into your finances.
- Both are accounted for as a business expense.
- Provide an understanding of an asset’s true value.
- Both types of expenses should be accounted for in tax returns.
- Both are deductible from taxes as business expenses, as long as they are in use.
If you’re struggling to repay debts, help is available. Check out our post on `what is a debt relief order`.
Company not paying invoice
Both amortization and depreciation are required as both types of assets are needed and indeed used in business, and both reflect the benefit of an asset and its associated costs over time.
If you’re struggling to collect on unpaid debts and find yourself in situations with an invoice not paid, please contact a member of our experienced and professional team.
Call us on +44 786 0197 476 or email with further information and details, memberbenefits@directroute.co.uk.