Amortisation

What it means

Amortisation is the gradual release of a cost into expenses. For an intangible asset - a software licence, a trademark, know-how - the purchase price is spread across the period the asset serves, and reaches profit in instalments.

On a loan the same word means paying down the principal: in the repayment schedule each instalment splits into interest, which is a cost, and amortisation of principal, which only reduces the payable to the bank and is not a cost at all.

A loan principal can be paid down in two ways. With an annuity repayment the instalment is the same every month and only its mix changes: interest dominates at first, principal towards the end. With straight-line amortisation the principal is repaid in equal parts and the instalment shrinks over time, because interest is charged on an ever smaller balance.

How it works in practice

Slovak practice usually says depreciation for tangible assets and keeps amortisation for intangibles and loans. Mechanically they are the same thing: an expense arises in a month when no money leaves the account.

That is exactly why amortisation is added back when cash flow and EBITDA are calculated. A company can report thin profit and still hold plenty of cash - the gap is the write-down of assets bought in earlier years.

When a company commissions a custom webshop or internal system, we read the contract with the supplier to see what exactly is being bought: a licence to use, the property rights, or just a service. That decides whether the amount goes into intangible fixed assets and is amortised over several years, or straight into expenses. The chosen period goes into the depreciation plan, so it does not have to be argued afresh every year.

What to watch out for

The classic mistake is expensing the whole loan instalment. Only interest is a cost; the rest moves inside the balance sheet. In the same way a multi-year licence cannot be written off in one month - it belongs in accruals and deferrals.

The opposite mistake is letting amortisation run on after the asset has stopped being used. The company moves to another system, the old licence expires, yet its balance keeps trickling into expenses for years. On disposal the remaining value has to be written off in one go, otherwise later years carry a cost for something the company no longer has.