What Is Depreciation? How It Affects Reported Profit

Depreciation

Glossary Deep Dive

What Is Depreciation? How It Affects a Business's Reported Profit

Depreciation and amortization both spread the cost of an asset over its useful life instead of expensing it all at once, matching the cost to the period the asset actually benefits the business. Both are non-cash expenses — they lower taxable income without any cash leaving the business, spreading the tax benefit out over time rather than taking it all at purchase.

Why it matters: Depreciation is one of the most common add backs in a business valuation, and understanding it well keeps both sides honest. Because it's a non-cash expense, it reduces reported profit on the P&L without actually costing the owner anything that year in real dollars — which means it needs to be added back when calculating SDE or adjusted EBITDA to see the true cash benefit of owning the business. Buyers should also look past the add back to the underlying asset: heavy depreciation on aging equipment can be a signal that real capital expenditure is coming due soon, even if it doesn't show up as a cash cost in the historical financials.

Example: A business bought a $60,000 delivery van three years ago and depreciates it over five years — about $12,000/year hits the P&L as an expense, even though no cash left the business this year for that van. That $12,000 gets added back when calculating SDE, but a buyer should still ask when the van (and similar aging equipment) will need actual cash to replace.

Depreciation vs. Amortization

	Depreciation	Amortization
Asset type	Tangible	Intangible
Examples	Buildings, machines, equipment, vehicles	Patents, licenses, copyrights, trademarks, leases
Non-cash expense	Yes	Yes
Salvage value	Applies	Doesn't apply
Impairment write-down	Possible	Possible