Financial statements course · Lesson 7 of 10
Depreciation is old capex, spread over the years.
When a company buys equipment, the cash leaves at once. The cost reaches the income statement slowly, as depreciation, over the life of the equipment.
From capex to depreciation
| Line | $ millions |
|---|---|
| Property and equipment, start of year | 360.0 |
| Add capital expenditure | 80.0 |
| Less depreciation | (40.0) |
| Property and equipment, end of year | 400.0 |
Example Co. spent $80 million on equipment last year. The cash flow statement shows all of it. The income statement shows only depreciation of $40 million, which comes from equipment that the company bought in earlier years.
Capex against depreciation
Example Co. spent 2.0x its depreciation. A ratio above 1 usually means that the equipment base grows. A ratio below 1 for many years can mean that the equipment gets old and that a large bill will come.
Companies do not report how much capex keeps the business as it is and how much makes it larger. A common estimate puts maintenance capex near depreciation. On that estimate, Example Co. spent $40 million on growth. Treat this as an estimate, not a fact.
The useful life is a choice
Equipment of $360 million at the start of the year and depreciation of $40 million imply about 9 years of life left. Suppose that the company decides that its equipment lasts 12 years.
| Line, $ millions | 9 years | 12 years |
|---|---|---|
| Depreciation | 40.0 | 30.0 |
| Net income | 137.5 | 145.4 |
| Cash from operations | 185.1 | 185.1 |
Depreciation falls to $30 million, and net income rises by $7.9 million. Cash from operations does not change. The company paid for the equipment in the past, and the new estimate does not give that cash back.
The notes state the useful lives. Compare them with other companies in the same industry. A company that makes its lives longer gets higher profit with no more cash.
Key points
- Capex is cash now. Depreciation is the cost, spread over the years.
- A capex to depreciation ratio below 1 for many years can mean old equipment.
- A longer useful life adds profit, not cash.