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Amortisation is a commonly used term in the financial world. Even if you’re unfamiliar with it, it probably applies to you as a business owner if you have taken out a startup loan, bridging loan or any other kind of business finance. To gain a granular understanding of every aspect of your business finances, so you can make more accurate projections, it’s important to understand amortisation. In this post, we’ll look closely at amortisation, what it means, how it’s calculated and why it matters to you and your business.
What is amortisation?
Amortisation refers to the routine decline in value of an intangible asset over time. It is also used to describe the repayment of a loan or finance agreement over a period of time. Amortisation is usually measured over a period of months or years, and is important to understand if you are to accurately calculate and project your business expenditure.
Amortisation vs depreciation: What’s the difference?
You’ve probably already noticed that amortisation sounds a lot like depreciation. And, in essence, they’re much the same thing. The difference is that amortisation refers to intangible assets, while depreciation refers to tangible assets. Your tangible assets are the physical assets that you use as part of your operations. Vehicles, computers, equipment, machinery and even your furnishings are considered tangible assets. They depreciate over time due to wear and tear or because they’ve been rendered obsolete by newer and more sophisticated equivalents.
Intangible assets are a little harder to define. However, the following are common examples of the intangible assets a business like yours may hold:
Copyrights and other proprietary processes
Patents and trademarks
Customer / lead lists
While tangible assets depreciate, they usually have some resale or salvage value. Intangible assets do not. What’s more, amortisation is usually fixed during each period within the asset’s life. Depreciation, on the other hand, grows over time.
Both amortisation and depreciation are important for accurate reporting and making realistic cash flow projections.
How do I calculate amortisation?
There’s a formula that you can use to calculate amortisation so that you can factor it into your projected finances:
In this formula:
P= Periodic payment amount
r= Interest rate per period
PV= Present Value
n= Number of periods
If you’re having trouble wrapping your head around this formula, let’s look at an illustrative example.
Amortisation calculation example
Let’s say your company has taken out a loan of $5 million to cover the costs associated with expansion into a new market. If you repay $250,000 of that loan per year, this is the amount of the debt that is amortised annually. However, you will also need to pay interest on this loan. Now let’s assume you have negotiated an annual rate of 10%, with your lender – $25,000. So you will need to pay $275,000 per year to fully amortise the debt.
As another example, let’s say that you had been given 10 years to repay $1.5 million in business loans to a bank on a monthly basis. In order to work out your monthly amortisation obligations, you would divide $1.5 million by 10, giving you $150,000 per year.
Why amortisation is important for business owners
Amortisation helps you to calculate the true cost of your borrowing and intangible assets. To maintain good financial health, you are required to not only account for today’s expenses, but tomorrow’s as well. Being able to calculate the amortisation on your assets and loans enables you to make confident and accurate cash flow projections and mitigate the risks that come from being unprepared.
We can help
If you’re interested in finding out more about amortisation, small business loans, or any other aspect of your small business finances, then get in touch with our financial experts at. Find out how GoCardless can help you with ad hoc payments or recurring payments.