Amortization Meaning & Why It Matters

Before applying for capital to give your small business a boost in cash flow, make sure you’re familiar with the lending terminology.

If you choose to apply for your SBA 7(a) loan through the SmartBiz Loans marketplace, you’ll come across the term “amortization.” Here’s what can help you understand the basics.
 

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What is Amortization?

In the context of lending, an “amortizing” loan is one that is spread throughout its term with regular fixed payments. The balance goes down with every installment until it is completely paid off, or amortized. SBA loans through SmartBiz® bank partners are fully amortizing, which means that your monthly payments will go toward paying down the balance until it’s reduced to zero. Learn more about the SBA loans and other financial products available through SmartBiz here.

Amortization is also involved when it comes to accounting for your small business. In that case, it has a similar definition: spreading the cost of a resource over a certain duration. But rather than applying to a loan, the term relates to the cost of your business’s assets.

How It Works

According to Investopedia, amortization is defined as “an accounting technique used to incrementally lower the cost value of a finite life or intangible asset through scheduled charges to income.”

Amortization is calculated by breaking down the cost of an intangible asset like a license, patent, or trademark into a certain number of payments over its useful life, which refers to the expected time in which the asset will serve its purpose for the company.

Dividing the intangible asset’s price by its useful life leaves you with the regular amortization. For example, if you spent $45,000 on a patent and expect it to last for 15 years, its annual amortization would be $3000. In other words, the asset’s value would decrease by $3000 every year.

 

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Amortization vs. Depreciation

The main distinction between amortization and depreciation is the assets that define them. While amortization is calculated specifically for intangible assets, which are not physical objects, depreciation is linked to tangible or fixed assets like equipment, machinery, and cars.

This leads to another difference: assets that have been amortized usually don’t have an inherent resale value, while assets that have been depreciated often do. When calculating depreciation, this amount, called the salvage value, is taken into account by subtracting from the total cost of the asset before dividing by the useful life.

Why They Matter

Amortization and depreciation often appear on income statements, also known as Profit and Loss (P+L) statements. This kind of financial document is one of the most commonly requested by lenders, because it helps them get a picture of your business’s performance over a period of several years.

Both amortization and depreciation also directly affect your business’s taxable income. Each year, the total depreciation and amortization are subtracted from your reported income, reducing the amount of taxes your company owes through deductions.

 

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* The information provided through SmartBiz Advisor, including the Loan Ready Score, is for educational purposes and is not the same as scores used by lenders for credit decisions. SmartBiz Advisor is not a financial or legal advisor as defined under federal or state law. Use of this information is not a replacement for personal, professional advice or assistance regarding your finances or credit history.