Depreciation
AccountingThe spreading of an asset's cost across the periods it is used, a real expense that consumes no cash.
Also written: depreciation and amortisation, D&A
When a company buys a long lived asset, the cost is not expensed at once. It is allocated across the asset's useful life, matching the cost to the periods that benefit from it. Amortisation is the same idea for intangibles.
It is non cash, which is why it is added back in the cash flow statement and why EBITDA excludes it. That does not make it fake: it is the accounting representation of assets wearing out, and a business that never replaces them eventually stops working.
This is the honest criticism of EBITDA. Adding depreciation back treats capital intensity as if it were free, which flatters a heavy manufacturer relative to an asset light business. For capital intensive sectors, EBIT or EBITDA less capex is the fairer comparison.
It is also a lever. Useful life and residual value are estimates, so extending assumed lives raises reported profit without changing anything real, and a company quietly lengthening depreciation schedules is worth a second look.
Worked example
An asset costing 500 with a ten year life depreciates at 50 a year.
Extending the assumed life to fifteen years cuts the annual charge to 33, raising reported profit by 17 a year with no change to the asset, the cash or the business.
That is why a company quietly lengthening depreciation schedules is worth a second look, and why EBITDA flatters capital intensive businesses by removing the charge entirely.