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What is Amortization?

Highlighted from a real earnings story. Explained by Clicked.

Used in a sentence

The Daily Ledger · Markets

The software costs will be amortized over five years, adding $40 million a year to expenses.

The reader highlighted one word mid-article. Clicked explained the finance term “amortized” in plain language:

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Overview

Amortization is the gradual working down of a starting amount on a schedule until it reaches zero. A loan amortizes as scheduled payments reduce the balance step by step across the term. A company amortizes a purchase, a patent, software, an acquired brand, by charging its cost against profits year by year across its useful life. Two settings, one idea: a fixed amount at the start, brought down to nothing over an agreed number of years.
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Overview

Amortization is a starting amount getting ground down to zero on a schedule. Your mortgage does it: each fixed payment covers that month's interest first, and what remains chips away at the actual loan, a portion that starts small and grows. Companies do it with purchases instead, charging a patent or software against profits a slice per year until the cost is used up. Either way, the schedule wins in the end. 😎

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Detail

Amortization is a starting amount brought down to zero on a schedule, in two settings: a loan being repaid, or a purchase cost being charged against profits. On a typical mortgage or car loan, the total payment stays fixed for the whole term. Each payment first covers the interest owed for that period, and the rest reduces the loan. Early on the balance is large, so the interest charge is large, and little of each payment is left to reduce the balance. As the balance falls, the interest charge falls, the part paying the loan down grows, and the loan shrinks faster. Bank term loans often run the other way around. The contract fixes the amount of loan repaid each period, the bank charges interest on top of the falling balance, and the total payment falls over time instead. In accounting, a company that buys something long-lasting but intangible, a patent, software, an acquired brand, spreads the cost evenly across its useful life, the years it expects to use it. Each of those years carries a share of the cost. That yearly charge is the amortization in EBITDA, the A that gets added back because it is an accounting entry rather than cash leaving. Physical assets get the same treatment under a different name, depreciation. A truck depreciates. The patent on its engine amortizes.
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Detail

Amortization is a starting amount worked down to nothing on a schedule. The loan version is where most people meet it. Years into a mortgage, the balance has barely moved, and that is the design. The payment is fixed, the bank collects its interest off the top, and the loan gets whatever is left. A big balance means a big interest bite, which is why the early years feel like running on the spot. The comfort is that the maths turns friendly later: smaller balance, smaller bite, and the loan finally starts falling properly. Some bank loans flip the arrangement, fixing the chunk of loan repaid each period and charging interest on top, so the total bill shrinks instead. The company version grinds down a cost instead of a debt. Buy software for a million, expect five years of use, and the accounts charge two hundred thousand a year rather than a million-dollar bruise in year one. Each year of use picks up its portion of the bill. No cash moves when that charge lands, which is exactly why EBITDA adds it back. 😎

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Analogy

A car loan with a fixed monthly payment. Each month, part of that payment covers the interest owed and the rest pays the loan down. In the first year the balance is at its biggest, so interest claims most of the payment and the balance barely falls. Because the balance keeps falling, each month's interest is a little smaller, and a little more of the same payment is left for the loan. By the final year interest claims almost none of it, and the balance drops faster than in any year before. The payment stayed the same for the whole term. What shifted is how the payment was divided.
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Analogy

A gym membership paid upfront for the year. The money left your account in January, all of it, one transaction. But nobody thinks of it that way. By March you are telling yourself each visit costs three dollars, because you have quietly spread one January payment across twelve months of Tuesdays. That is the whole move: the paying happened once, the counting happens all year. Companies just do it with software and patents, and with an accountant keeping the schedule instead of a guilty conscience. 😎
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AI explanations may contain errors · Not professional advice

Formal definition — The same term, explained the usual way

Amortization denotes the systematic allocation of an amount over a defined period. In lending, it refers to the retirement of principal through scheduled payments, each comprising the interest accrued for the period together with a principal component, such that the outstanding balance reduces progressively over the term according to an amortization schedule. In financial reporting, it refers to the systematic expensing of the cost of an intangible asset over its useful life, the counterpart of depreciation as applied to tangible assets, and constitutes the amortization added back in EBITDA. In both applications the amount amortized is fixed at the outset and allocated across periods rather than recognized when paid.

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