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Is Depreciation And Amortisation

Is Depreciation And Amortisation

Income statement depreciation and amortization is the combined non-cash expense for both tangible and intangible assets. It reduces reported earnings but does not affect cash flow.

Depreciation and amortisation (D&A) on the income statement represents the combined non-cash expense for allocating the costs of both tangible assets (depreciation) and intangible assets (amortisation) over their useful lives. These expenses reduce reported income but don't consume cash, making D&A a critical adjustment when analysing cash flow and calculating metrics like EBITDA.

The components:

  • Depreciation: Physical assets—property, plant, equipment, vehicles
  • Amortisation: Intangible assets—patents, customer relationships, technology

Income statement impact:

Operating Income = Revenue - COGS - Operating Expenses (including D&A)

Why D&A matters:

  • Profitability measure: Affects operating income and net income
  • EBITDA calculation: EBITDA = Operating Income + D&A
  • Cash flow reconciliation: Added back to net income to calculate operating cash flow
  • Capital intensity indicator: High D&A suggests significant asset base

Analysing D&A:

  • D&A as % of revenue: Indicates capital intensity
  • D&A vs. CapEx: Shows whether assets are being replaced or depleted
  • Trend analysis: Changes reflect asset base growth or reduction

Industry variations:

  • Utilities: 10-15% of revenue; massive infrastructure
  • Manufacturing: 5-10% of revenue; significant equipment
  • Retail: 3-6% of revenue; store build-outs and fixtures
  • Software: 2-4% of revenue; minimal physical assets

D&A and maintenance CapEx:

  • D&A ≈ Maintenance CapEx: Assets being maintained (roughly)
  • CapEx > D&A: Net investment in growth
  • CapEx < D&A: Asset base declining; potential underinvestment

Important perspective:

While D&A is non-cash, it represents real economic consumption of assets that must eventually be replaced. Treating D&A as "not real" because it's non-cash ignores the capital required to maintain business operations. Use EBITDA for certain analyses, but always consider that assets require replacement investment.

Track D&A trends alongside capital expenditure patterns to understand whether a company is investing sufficiently to maintain its competitive position and asset base.