Depreciation and amortization
5 min read · updated July 2, 2026
Here's the whole idea in one line: when a company buys something that lasts for years, it doesn't expense the whole cost the day it pays. It spreads that cost across the years the asset actually earns its keep. That spreading is depreciation and amortization (D&A).
Depreciation is for tangible assets: buildings, machines, trucks, servers. Amortization is the same mechanic for intangible assets: patents, customer lists, software, licenses. Different words, identical logic. Buy the asset once, expense it slowly.
Why spread the cost at all?
Because expensing a $500 machine all at once would make the year you bought it look terrible and every year after look fantastic. Neither is true. The machine helps produce revenue for, say, five years. So accounting matches the cost to the revenue it helps generate. That's the matching principle, and it's the reason the income statement shows a slice of the cost each year instead of the full hit up front.
Simple example. A $500 machine with a 5-year life, straight-line, no salvage value:
So $100 shows up as an expense on the income statement every year for five years. The cash left the building on day one. The expense arrives in installments.
D&A is an accounting expense, not a cash expense. The company already paid for the asset. Depreciation is just the bookkeeping that recognizes the cost over time. That single fact drives everything else in this lesson.
Where D&A lives on each statement
D&A touches all three statements, and knowing exactly where is a common Superday follow-up.
| Statement | What D&A does | |---|---| | Income statement | Shows up as an expense (in COGS, in operating expenses, or on its own line), lowering pre-tax income | | Cash flow statement | Added back at the top of cash from operations because it's non-cash | | Balance sheet | Reduces the asset's book value; accumulated depreciation grows, net PP&E shrinks |
Notice the tension. On the income statement, D&A is a cost that reduces profit. On the cash flow statement, you add it right back. That looks like a contradiction to beginners. It isn't. You subtracted it for accounting purposes, but no cash actually left, so you reverse it to get back to real cash movement.
The one real cash effect: the tax shield
If D&A is non-cash and gets added back, does it touch cash at all? Yes, in exactly one place. It lowers your taxable income, so you pay less tax. That saved tax is real cash in your pocket. Bankers call it the tax shield.
Walk the $100 of depreciation through, at a 25% tax rate:
| Line | Effect | |---|---| | Pre-tax income | down $100 | | Taxes (25%) | down $25 | | Net income | down $75 | | CFS: net income | down $75 | | CFS: add back D&A | up $100 | | Net change in cash | up $25 |
Cash rose by $25. That $25 is the depreciation ($100) times the tax rate (25%). It's the only cash D&A ever moves, and it moves in your favor. More depreciation, lower taxes, more cash today. That's why tax rules often let companies depreciate faster than the economic reality: it front-loads the shield.
Forgetting the tax shield. Two versions of this trip people up. First, they say depreciation has "no cash effect because it's non-cash," missing that the tax savings are very real cash. Second, in a walk-through they subtract D&A on the income statement and then forget to add it back on the cash flow statement, so their balance sheet doesn't balance. Say it out loud every time: non-cash, add it back, and the only cash it moves is the tax it saves.
For the full mechanics of tracing a change through all three statements, see the $10 depreciation walk. It's the single most tested set-up in accounting interviews.
Depreciation vs. amortization vs. impairment
They rhyme, so keep them straight.
- Depreciation writes down tangible assets on a schedule. Predictable, recurring.
- Amortization writes down finite-life intangibles on a schedule. Same idea, intangible assets.
- Impairment is different. It's a one-time write-down when an asset (often goodwill) is suddenly worth less than its book value. Goodwill isn't amortized under US GAAP; it's tested and impaired when needed. Like D&A, an impairment is non-cash and gets added back, but it's a surprise event, not a schedule.
Why this matters for valuation
D&A is the bridge between two metrics you'll live in. EBIT is earnings after D&A. EBITDA is earnings before it. So:
People love EBITDA because it strips out D&A and looks like a clean cash proxy. Be careful. EBITDA ignores the CapEx that created the assets in the first place. A company can post gorgeous EBITDA and still burn cash if it has to keep spending on new equipment. Depreciation is the accounting echo of past CapEx. Ignore one and you'll misjudge the other. This ties straight into enterprise value vs. equity value and how you read EV/EBITDA against EV/FCF.
When they ask "what happens to the three statements if depreciation goes up $10," don't recite a memorized list. Sequence it: income statement first (pre-tax down $10, taxes down at the rate, net income down by the after-tax amount), then cash flow (net income down, add back the full $10, net cash up by the tax savings), then balance sheet (cash up by the shield, PP&E down $10, retained earnings down by the after-tax hit, and confirm it balances). Saying it in that order, out loud, in under thirty seconds, with the balance sheet balancing at the end, is the depth that separates you in a Superday.
Glossary
New to the lingo? Every term used above, in plain English.
- D&A (Depreciation and Amortization)
- Spreading the cost of long-lived assets over the years they are used. Depreciation is for physical assets, amortization for intangible ones. Both are non-cash expenses.
- PP&E (Property, Plant and Equipment)
- The long-lived physical assets a company uses to operate, like buildings, machines, and equipment. Its value drops over time through depreciation.
- Amortization
- Spreading the cost of an intangible asset (like a patent or software) over its useful life. It is the intangible-asset version of depreciation, and it is also non-cash.
- Non-cash charge
- An expense that lowers reported profit but involves no cash leaving the company, such as depreciation or amortization. It gets added back on the cash flow statement.
- Income statement
- The report that shows whether a company made a profit over a period, running from revenue at the top down to net income at the bottom.
- Cash flow statement
- The report that tracks the actual cash moving in and out of a company, bridging accrual profit to real cash. It explains why a profitable company can still run low on cash.
- Net income
- A company profit after all expenses, interest, and taxes are taken out. It is the bottom line of the income statement, also called earnings.
- Tax shield
- The tax a company saves because an expense is deductible. Depreciation, for example, lowers taxable income, so it saves cash on taxes even though it is non-cash.
- EBIT (Earnings Before Interest and Taxes)
- A company operating profit before interest and taxes are taken out. It measures how much the core business earns regardless of how it is financed.
- EBITDA
- Earnings Before Interest, Taxes, Depreciation, and Amortization. A rough proxy for a company’s operating cash profit, before financing and accounting choices.
- CapEx (Capital Expenditures)
- Cash a company spends to buy or upgrade long-lived assets like equipment, factories, or technology. It is an investment in the business, not a day-to-day expense.
- Goodwill
- An accounting plug created when a buyer pays more for a company than the fair value of its identifiable net assets. It captures things like brand and customer relationships.
- Impairment
- A write-down taken when an asset, often goodwill, is worth less than its value on the books. It is a non-cash charge that lowers reported profit.
Make it stick
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