Understanding Depreciation and Amortization: A Guide for Investors

Depreciation (Depreciation) is an important accounting concept that impacts a company's financial analysis. It itself is not a cash payment but an accounting tool used to reduce the book value of assets on the income statement. When investors read financial reports, they need to understand how depreciation and amortization work, as these can distort the picture of a company's profitability.

How Depreciation Works

Tangible assets such as buildings, machinery, and vehicles lose value over time. Depreciation is the allocation of the initial cost of these assets over their estimated useful life. For example, if a company purchases a vehicle for 100,000 THB with an expected useful life of 5 years, it will record 20,000 THB in depreciation expense each year.

In English, the term "Depreciation" describes this process. The concept of depreciation in English is similar to that in Thai: a reduction in the asset's book value over time.

It is important to note that the useful life of an asset depends on estimates. For instance, a laptop might have a useful life of 5 years, while a building might last 40 years. Depreciation is included in the calculation of EBIT (Earnings Before Interest and Taxes), a key indicator for investors.

EBIT vs EBITDA: Key Differences

EBIT stands for Earnings Before Interest and Taxes, representing profit before deducting interest and taxes. Depreciation and amortization are already deducted in this figure.

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, meaning profit before deducting interest, taxes, depreciation, and amortization. When calculating EBITDA, depreciation and amortization are added back.

Investors use EBITDA because it shows a company's ability to generate income without the effects of depreciation methods. Companies with significant fixed assets may have low EBIT but high EBITDA, providing a clearer picture of profit-generating capacity.

Assets That Can Be Depreciated

Assets eligible for depreciation must have the following characteristics:

• Owned by the company and used in business operations
• Have a useful life longer than one year
• Are tangible assets

Common depreciable assets include vehicles, buildings and structures, furniture and office equipment, computers, machinery, and even intangible assets such as software, patents, and copyrights.

Assets that cannot be depreciated include:

• Land () (since it has an indefinite useful life)
• Personal property
• Collectibles such as art and coins
• Investments like stocks and bonds
• Assets used for less than one year

How to Calculate Depreciation

1. Straight-line Method(

This is the simplest and most commonly used method, where the same amount is deducted each year.

Formula: )Cost of the asset - Residual value( ÷ Useful life

Advantages: Easy to calculate and understand; suitable for small businesses.

Disadvantages: Does not account for rapid loss of value in the first year or increasing maintenance costs at the end of the asset's life.

) 2. Double-declining Balance Method###

This method accelerates depreciation in the early years and decreases in later years. Suitable for assets that lose value quickly, such as vehicles.

Advantages: Provides greater tax deductions early on; good for recovering costs rapidly.

Disadvantages: More complex than straight-line; may produce distorted results initially.

( 3. Declining Balance Method)

Similar to the double-declining method but uses a different depreciation rate. The asset's book value is reduced by a fixed percentage each year.

4. Units of Production Method(

Depreciation is based on actual usage rather than time. Suitable for machinery and equipment used in production.

Advantages: Accurately reflects actual usage.

Disadvantages: Requires precise tracking of usage, which can be complicated.

What is Amortization)?

Amortization is a concept similar to depreciation but applies to intangible assets and loans.

###Amortization of Intangible Assets(

Intangible assets such as copyrights, patents, trademarks, and software have a defined useful life. For example, if a company pays 10,000 THB for a patent expected to last 10 years, the amortization expense is 1,000 THB per year.

)Amortization of Loans(

When a company or individual repays a loan, such as a car loan or mortgage, each payment includes principal and interest. In the early stages, most payments are interest. Over time, the principal portion increases while interest decreases.

Example: If you borrow 10,000 THB and pay 2,000 THB annually toward principal, the amortization expense per year is 2,000 THB.

Differences Between Depreciation and Amortization

| Aspect | Depreciation | Amortization | |--------|--------------|--------------| | Assets | Tangible assets )buildings, machinery### | Intangible assets and loans | | Methods | Various ###straight-line, declining balance, etc.( | Usually straight-line only | | Final Value | May have residual value | Usually zero at end of useful life | | Disclosure | Shown separately on balance sheet | Included in other expenses |

Impact on Investment Analysis

Depreciation and amortization affect a company's profit figures. Investors must understand the differences. When comparing two companies—one with many fixed assets and another with few—the first may have lower EBIT but similar EBITDA.

This explains why highly leveraged companies tend to have high interest expenses. EBIT removes interest costs, providing a clearer view of earnings potential before financial costs.

Summary

Both depreciation and amortization are essential concepts for understanding a company's finances. Depreciation applies to tangible assets, while amortization relates to intangible assets and loans. Knowing how to calculate and how they impact EBIT and EBITDA helps investors make better financial analysis and investment decisions.