What Is Amortization?
In accounting, amortization is the intangible-asset counterpart to depreciation: it spreads the cost of assets like patents, licenses, software, and acquired customer lists across the years they provide value. It appears on the income statement as a non-cash expense and is added back on the cash flow statement.
The same word has a second meaning in lending, where an amortizing loan is one whose principal is paid down gradually over its life. A 30-year mortgage is the classic example, with early payments mostly covering interest and later payments mostly principal.
How It Works
Intangibles with a definite life are usually amortized straight-line: Annual Amortization = Asset Cost / Useful Life. Amortization expense is especially large after acquisitions, because purchase accounting requires buyers to recognize intangibles like customer relationships and trade names and expense them over time.
Goodwill, by contrast, is not amortized under U.S. GAAP; it is tested annually for impairment instead. That distinction between amortizable intangibles and goodwill comes up frequently in M&A accounting.
Example
A pharmaceutical company pays $20 million for a patent with 10 years of remaining life. It records $2 million of amortization expense each year, reducing pre-tax income by $2 million while the patent's balance sheet value declines in step. No cash leaves the company in those years, so the $2 million is added back in the operating section of the cash flow statement.
Why It Matters
Amortization is the A in EBITDA, and adding it back can meaningfully flatter the earnings of highly acquisitive companies. Analysts often look at earnings both with and without acquisition-related amortization to judge underlying profitability.
Understanding both meanings of the word, expensing intangibles and scheduling debt paydown, is expected knowledge in banking interviews and LBO modeling, where debt amortization schedules drive returns.
