Have you ever tried to sell a used vehicle? Once a vehicle leaves the dealer lot, it immediately begins to lose value. The same holds true for other items of value – jewelry, equipment, even money. Many material goods never see their full return on investment once they are used. This same phenomenon happens in business. Many of the assets your business relies on to keep it operational lose value as time goes on. This reduction in value – in addition to other non-cash factors that increase your business’s available cash – is recorded on the Cash Flow Statement. Depreciation is the reduction in value over time of a tangible asset. Tangible assets include such things as real estate, vehicles, equipment, and inventory. Real estate is the only tangible asset that does not depreciate. Amortization is the reduction in value over time of an intangible asset. Intangible assets include goodwill, trademarks, product patents, and copyrights. Besides goodwill, intangible assets amortize. Depreciation and amortization are booked as loss of income on the Cash Flow Statement, but because they have no cash effect, they are considered non-cash events, made up of both non-cash charges and non-cash income. In addition to depreciation and amortization, non-cash events include, but are not limited to:
- deferred taxes
- provisions for bad debt and non-paying customers
- accrued charges (charges incurred in an accounting period not fully paid by the end)
Depreciation, amortization, deferred taxes, provisions for bad debt, and accrued charges result in losses on the Cash Flow Statement because they are all considered non-cash charges. These costs must be recouped through revenue-generating functions in your business.