Deprecation & Amortization

You may have heard about EBITDA, but what are the D and the A?

You may have heard of “EBITDA”, a common profit metric investors use that is not actually on the income statement 📊

Before we dive into it, let’s learn about the “D” and the “A” 🔍

Depreciation (the “D”) is when physical assets decrease in value over time 🏭

Companies calculate depreciation expense by spreading out the original cost of a physical asset over a period of time, like 10 years

The idea behind depreciation is that physical things you own become less valuable over time, so that loss of value should be recorded as an expense every year you use it ⏳

Say our T-Shirt company bought a sewing machine for $500, and expects it to last 10 years 🧵

This $500 cost will be spread out as a $50 expense each year for 10 years instead of a $500 expense in the first year.

Amortization (the “A”) is spreading out the cost of intangible assets over time 🔑

Intangible assets are any asset that is not physical, like a logo, patent, copyright or piece of software 💻

Say the T-shirt company paid $1,000 to secure a copyright on its name 📜

In this case, they could include $100 of amortization expense on their income statement each year for 10 years.

So, when using either depreciation or amortization, a company would not record the one-time cost of the asset they bought as an expense; instead they spread out the cost over time 📅

Lastly, depending on exactly what asset the company bought, both depreciation and amortization expenses can get included in either COGS or Operating Expenses 📚

If the asset is directly used in the production of goods or services, for example a sewing machine, it’d be in COGS, whereas if not, for example a copyright, it’s in Operating Expenses 🛠️

Now that we know what D&A is, let’s see how we can use it to find EBITDA 🧮

Test your knowledge

What does Depreciation spread out over time?

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What is an example of an intangible asset?

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Where might Depreciation expenses be included?

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What does "A" stand for in EBITDA?

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What does Amortization spread out over time?

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What's next?

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