Depreciation / Amortization
The accounting allocation of an asset's cost over its useful life. A non-cash expense added back to net income to calculate EBITDA — the profitability measure used in business valuation.
Definition
Depreciation and amortization are the accounting methods that spread the acquisition cost of an asset over its estimated useful life. In English, depreciation applies to tangible assets (equipment, vehicles, buildings) and amortization applies to intangible assets (patents, software, goodwill). In French-language Quebec documentation, you’ll see amortissement used as a single term covering both concepts.
This is a non-cash accounting expense: the business makes no cash outlay at the moment depreciation is recorded. The money was already spent when the asset was acquired. Depreciation reduces net income on the income statement but doesn’t affect the business’s actual cash flows.
Why depreciation and amortization matter in a business sale
Depreciation plays a central role in business valuation because it’s part of the EBITDA calculation (earnings before interest, taxes, depreciation and amortization). EBITDA is obtained by adding depreciation back to operating income — neutralizing that non-cash expense. That’s precisely why EBITDA is the preferred measure in M&A: it reflects the business’s real ability to generate cash, regardless of depreciation accounting choices.
A seller should understand that the depreciation policies chosen by their accountant (straight-line, declining balance, estimated useful lives) affect reported net income but not EBITDA or cash flow. Two identical businesses using different depreciation methods will show different net income numbers but the same EBITDA. That’s one of the reasons buyers rely on EBITDA rather than net income.
It’s also important to distinguish accounting depreciation from capital cost allowance (CCA) — the tax equivalent set by CRA. CCA is the depreciation amount deductible for tax purposes, based on rates prescribed by the CRA. It often differs from accounting depreciation and has direct tax implications at sale, especially the concept of CCA recapture, which can trigger additional tax at closing.
What every seller should know
- Depreciation is a non-cash expense: it reduces your net income on paper but not your cash — that’s why buyers look at EBITDA, which neutralizes this expense.
- High depreciation combined with low capital spending (capex) can concern a buyer: it may signal aging assets that will have to be replaced after the acquisition.
- In an asset sale, CCA recapture (recovered capital cost allowance) is taxable as ordinary income — discuss this tax impact with your accountant before choosing between a share sale and an asset sale.
- Make sure the depreciation records for your fixed assets are up to date and reconciled with your financial statements — it’s an item systematically verified during due diligence.