Amortisation has two distinct meanings:
- It is the practice of reducing the value of assets to properly reflect their value over time.
- It can mean the servicing of debt in regular increments.
Reducing the value of assets to properly reflect their value over time
Amortisation is a balance sheet process where the value of an asset is reduced over a certain period of time depending on the relevant accounting standards. Amortisation is essentially the same as depreciation though has a slightly different meaning. Namely, amortisation more specifically refers to the process of writing off intangible assets (usually goodwill, but can also refer to trademarks, patents, and other forms of intellectual property). Depreciation is more generally used to describe the diminished value of fixed capital.
Servicing of debt in regular increments
Amortisation can also mean the periodic payment of principal and interest payments as it pertains to debt. For example, an agreement that a $12,000 loan would be paid off in $500 monthly increments over 24 months would be considered an “amortisation schedule”.
Example of Balance Sheet Amortisation
Let’s say an auditor looks into a company’s balance sheet and determines that a company’s goodwill – an intangible asset typically generated during merger and acquisition transactions – has dropped from $10 million to $7 million. This would result in an amortisation charge of $3 million (i.e., $10 million minus $7 million).
This would affect the three financial statements by reducing goodwill (an asset on the balance sheet) by $3 million. This would, in turn, reduce earnings on the income statement by $3 million. Since this is not cash-related – namely, an amortization charge does not result in a cash loss for the company – this $3 million would be added back on the cash flow statement under “cash flow from operations” resulting in no net change in a company’s liquidity position. To balance the balance sheet, the $3 million reduction in earnings would plug into retained earnings and result in a $3 million deduction in that account.
Amortisation’s Relevance to Day Trading
A reduction in a company’s asset base is a net negative (and vice versa, with an increase in a company’s asset base being a net positive). So if a company is writing off assets, this could be a bearish event for a company’s stock in relation to the extent of the write-off.
This is not something that those who exclusively focus on technical analysis would ever concern themselves with. However, it could be relevant to those who perform deep-dive fundamental analysis and really dig into a company’s balance sheet to compare assets versus their intrinsic value. Viable long/short theses on certain securities can thereby be formed if asset values are different relative to what the market is pricing in.