When you spend CapEx, the cash leaves your bank account immediately, but the expense hits your P&L statement slowly over time. This spreading mechanism has two names depending on the type of asset involved.
Depreciation (Tangible Assets)
Used for physical hardware and equipment.
- Scenario: You buy a server for $100,000. Finance determines it has a useful life of 5 years.
- Impact: You record a $20,000 depreciation expense on your P&L each year for 5 years. In year one, your cash is down $100K but your reported expense is only $20K.
- Common depreciation schedules in tech: Servers (3–5 years), networking gear (5–7 years), data center infrastructure (10–20 years).
Amortization (Intangible Assets)
Used for non-physical assets, including software licenses and internally developed software.
- Scenario: You purchase a perpetual enterprise software license for $50,000 with a 5-year useful life. Or your engineers spend $50,000 in salaries building a proprietary internal platform (called Capitalized Software Development).
- Impact: You amortize that $50,000 over the useful life — $10,000 per year on the P&L.
Straight-Line vs. Accelerated Depreciation
The most common method is straight-line (equal amounts each year). Some companies use accelerated depreciation (larger amounts early, smaller later), which front-loads the expense and reduces taxable income sooner. The US tax code even allows bonus depreciation — writing off 100% of certain assets in year one for tax purposes, while still using straight-line for financial reporting. This creates a gap between "book" and "tax" accounting that finance teams manage carefully.
Key Takeaway: Both mechanisms allow a company to smooth out massive purchases so they do not appear as catastrophic losses in a single quarter. This is by design — it more accurately matches the economic benefit of the asset to the period in which that benefit is received.