What is Amortization?
Amortization is depreciation for intangible assets. It spreads the cost of things like patents, software licenses, and acquired customer lists over the period you will benefit from them.
Why Amortization Matters
For SaaS companies that acquire other businesses, amortization of intangibles often becomes significant. The customer relationships, technology, and brand value you acquired get expensed over time through amortization.
Like depreciation, amortization is a non-cash expense that reduces taxable income. Understanding it helps you reconcile accounting profit with cash flow.
Amortization vs Depreciation
Depreciation applies to tangible (physical) assets. Amortization applies to intangible assets. The concept is identical, but the terminology differs based on asset type.
Formula
Amortization = Intangible Asset Cost ÷ Useful Life or Legal Life
Example
Your SaaS company acquires a competitor:
- Acquired Technology Value: $500,000
- Useful Life: 5 years
Annual Amortization = $500,000 ÷ 5 = $100,000
Each year you expense $100,000 of the acquired technology value, reducing reported earnings but not cash flow.