Head-to-head
Depreciation vs Amortization
Both spread an amount over time in a straight, predictable pattern. That is where the similarity ends. Depreciation allocates the cost of a long-lived asset across the years that benefit from it. Amortization, in its lending sense, is the schedule that pays a loan down to zero.
The directions are opposite. Depreciation reduces the carrying value of something the business owns; amortization reduces the balance of something the business owes. Depreciation never involves interest. Amortization is mostly interest at the start, and on a long mortgage the first payment can be four-fifths interest.
The word also carries a second accounting meaning: spreading an intangible asset such as a patent, a licence or a loan origination fee over its useful life, which is much closer to depreciation. Context decides which one is meant. If the thing being spread is an asset you bought, it is depreciation or amortization of an intangible. If it is a debt you took on, it is an amortization schedule. The quick test is to ask what each payment reduces: if the answer is a balance you owe, you are amortizing, and interest is the part of the payment that buys nothing.
Depreciation
How To Calculate Depreciation
Straight-line depreciation spreads an asset's cost evenly across its useful life. It is the simplest and most common method, and it turns a large purchase into a predictable annual expense.
Amortization
How To Calculate An Amortization Schedule
An amortization schedule is the month-by-month ledger of a fixed-rate loan: every payment is the same size, but the split between interest and principal shifts a little each month. Early on almost everything goes to interest; near the end almost everything goes to principal. The monthly payment comes from one formula, and from it you can read off the first month's interest, the principal that payment retires, and the balance left afterwards.
How They Differ
| Attribute | Depreciation | Amortization |
|---|---|---|
| What is spread | The cost of an asset | The repayment of a loan |
| Direction | Asset value falls | Liability falls |
| Base amount | Cost minus salvage | Principal borrowed |
| Interest | Not involved | Front-loaded, the largest early component |
| Typical pattern | Straight line, or an accelerated method | Payment fixed, split shifts from interest to principal |
| Total over the term | $30,000 of expense on the example | $41,758.85 of cash for $36,000 borrowed |
| Effect on reported profit | Reduces it each year | Only the interest reduces it |
| Effect on cash | None directly | The whole payment leaves the bank |
| Tax treatment | Deductible, subject to local rules | Interest may be deductible; principal is not |
| Balance sheet line | Property, plant and equipment | Loans payable |
The Same Numbers, Both Ways
A $36,000 delivery van with $6,000 of salvage value over five years, beside a $36,000 loan at 6% over the same five years.
- Asset cost
- $36,000
- Salvage value
- $6,000
- Useful life
- 5 years
- Loan principal
- $36,000
- Loan rate
- 6% a year
| Line | Depreciation | Amortization |
|---|---|---|
| Amount spread | $30,000 | $36,000 |
| Per year | $6,000 | $8,351.77 |
| Per month | $500.00 | $695.98 |
| Interest inside it | $0.00 | $5,758.85 |
| Total over five years | $30,000 | $41,758.85 |
| Balance at the end | $6,000 | $0.00 |
The van gives up $30,000 of value in five equal $6,000 slices and ends worth $6,000 of salvage. The loan takes $695.98 a month, $41,758.85 in total, of which $5,758.85 is interest — and it ends at zero. Same five years, opposite directions.
When To Use Each
Depreciation
- You are spreading the cost of equipment, vehicles or buildings across the years that use them.
- You are preparing accounts or a tax return and need an annual expense figure for an asset.
- You are comparing the profit impact of buying an asset outright against leasing it.
Amortization
- You are working out what a loan will actually cost each month and over its whole term.
- You need the split between interest and principal in an early payment.
- You are deciding whether to refinance, where the remaining balance and remaining interest matter.
Common Questions
Why is amortization mostly interest at the beginning?
Because interest is charged on the outstanding balance, and the balance is at its largest in month one. With a fixed payment, whatever is left after interest goes to principal, so the principal share grows as the balance shrinks. On a 30-year mortgage the crossover point is roughly year 18.
Is amortization ever used for assets?
Yes. Intangible assets — patents, trademarks, software, goodwill in some jurisdictions — are amortized rather than depreciated. The arithmetic is the same as straight-line depreciation; only the asset class differs.
Does depreciation reduce cash flow?
No. It is a non-cash charge: no money leaves the business. It reduces reported profit and therefore tax, which is why it appears as an add-back in a cash flow statement and why EBITDA exists.
Can I depreciate below salvage value?
Not under straight-line accounting. The depreciable base is cost minus salvage, and the schedule stops when book value reaches salvage. Tax rules in some jurisdictions allow the full cost to be written off, which is one of the reasons book and tax depreciation often differ.
What happens if the loan is paid off early?
The remaining balance falls to zero immediately and the interest you would have paid disappears. That is why early repayment saves far more than the sum of the remaining payments suggests — most of those payments were going to be interest.
More Comparisons
- EBITDA vs Cash Flow
EBITDA of $200,000 becomes $105,000 of operating cash flow once interest, tax and working capital are paid, and $45,000 of free cash flow after $60,000 of capital spending. Only 22.5% of the headline figure survives.
- NPV vs IRR
NPV returns a dollar surplus and IRR returns a rate. Five annual payments of $30,000 on a $100,000 outlay are worth $19,781.30 at an 8% discount rate and an IRR of 15.2% — the same cash flows answering two different questions.
- Break-Even vs Payback Period
With $120,000 of fixed costs and $16 of contribution per unit, break-even is 7,500 units a year. The $300,000 machine behind them takes 7.5 years to repay at 10,000 units. Break-even asks how much you must sell, payback asks how long you wait.
Sources
- Depreciation — methods and accounting treatment — Corporate Finance Institute
- Amortization — loan schedules and intangible assets — Corporate Finance Institute
- How to depreciate property — Publication 946 — Internal Revenue Service
Both methods sit in Business.