Non-Cash Expense
A non-cash expense is an expense reported on the income statement of a company that does not involve a cash payment. These expenses are often depreciation and amortization.
- Depreciation: This is a non-cash expense that reduces the value of an asset as it wears out over time. For instance, if a company buys a piece of machinery for $10,000 that has a useful life of 10 years, the company might depreciate the machinery by $1,000 each year. This $1,000 is reported as an expense on the income statement, reducing the company’s net income, but it doesn’t involve any actual cash outlay during the year it’s recorded.
- Amortization: This is similar to depreciation, but it’s used for intangible assets like patents or copyrights, which have a finite useful life. For instance, if a company acquires a patent for $100,000 that has a 10-year life, the company would recognize a $10,000 amortization expense each year, reducing the value of the patent on the balance sheet and the company’s net income on the income statement. Again, this doesn’t involve any actual cash outflow.
The importance of non-cash expenses is that while they reduce a company’s reported earnings, they don’t reduce cash flow. That’s why analysts often add them back into net income when they’re analyzing a company’s cash flow.
Example of a Non-Cash Expense
Assume a company purchases a delivery truck for $100,000. The truck has a useful life of 10 years, after which the company estimates it will have no residual value. The company uses straight-line depreciation, which means it depreciates the truck evenly over its useful life.
Each year for 10 years, the company will record a depreciation expense of $10,000 ($100,000 / 10 years). This $10,000 is subtracted from the company’s earnings when calculating net income for the year. It’s an expense because it represents the portion of the truck’s value that has been used up. However, no cash actually leaves the company in relation to this expense in any of those years.
So, in this case, the depreciation expense of $10,000 each year is a non-cash expense. It reduces the company’s reported net income, but it doesn’t reduce the company’s cash balance. Therefore, when analysts or investors look at the company’s cash flows, they would add back the $10,000 depreciation expense to the net income for each of the ten years.
