Depreciation is a reduction in the value of an asset with the passage of time. It records the loss in value of machines, equipment, or cars that the company purchased due to wear and tear.

Amortization means prorating the cost or machines, equipment, or cars over a period of years. Or it is also the paying off of debt in regular installments over a period of time.

Depreciation/Amortization is an expense that needs to be considered when searching for a company with a Durable Competitive Advantage. Making investments on equipment that falls in value due to wear and tear is like throwing money away.  Therefore, we are interested in companies whose business model does not require huge equipment purchases. We compare Depreciation/Amortization to Gross Profit to see how much  the company's equipment expenses are eating away profits. As a guide, the ratio Depreciation/Amortization to Gross Profit, should be less than 10%. Less is better.

Equation

Example 1

Cola-Cola does not have any recorded Depreciation/Amortization expenses in the year 2010. Their Gross Profit for that year was $22.426 Billion.

Date: Year 2010
Company: Coca-Cola
Depreciation/Amortization: $0
Gross Profit: $22.426 Billion

Coca-Cola does not record their Depreciation/Amortization expense on their Income Statement, however, it is probably being recorded someplace else.

Example 2

IBM spent $289 Million is Depreciation/Amortization cost in the year 2011 with Gross Profits of $50.138 Billion.

Date: Year 2011
Company: IBM
Depreciation/Amortization: $289 Million = $0.289 Billion
Gross Profit: $50.138 Billion

Even though IBM has Depreciation/Amortization expenses, it is extremely very low. They mostly provide computer and software services as opposed to Oracle Corporation who mostly sells computer hardware and software programs.

Example 3

American Airlines has $1.093 Billion in Depreciation/Amortization costs in 2010 and Gross Profits of only $1.719 Billion.

Date: Year 2010
Company: American Airlines
Depreciation/Amortization: $1.093 Billion
Gross Profit: $1.719 Billion

American Airlines has an extraordinary huge expense on Depreciation/Amortization. They filed for bankruptcy in November 2011.