Unveiling the Hidden Impact of Non-Cash Charges on Financial Health
A non-cash charge represents a significant financial adjustment on a company’s accounts that doesn’t involve an immediate cash outflow. These charges can affect a company’s financial standing by impacting its earnings without altering its short-term capital. Common non-cash charges include depreciation, amortization, depletion, stock-based compensation, and asset impairments, all of which reduce earnings but do not impact cash flows.
Key Takeaways
- Non-cash charges are accounting expenses that require no direct cash payment.
- Examples include depreciation, amortization, depletion, stock-based compensation, and asset impairments.
- These charges are necessary for firms utilizing accrual basis accounting.
Understanding a Non-Cash Charge
Non-cash charges appear in a company’s income statement and are crucial for those using accrual basis accounting, a system that records financial transactions regardless of cash movement. Here’s a closer look:
Accrual Accounting
Depreciation, amortization, and depletion are spread over the useful life of an asset, reflecting its ongoing indigence rather than its initial cash payment. Recorded in the balance sheet, these charges lower the value of relevant items over set periods:
- Depreciation: When a company buys new equipment, a calculated portion of its cost is deducted annually over its useful life, accounting for wear and tear.
- Amortization: This operates like depreciation but for intangible assets like patents and trademarks. For instance, a $100,000 patent expensed over ten years means an annual amortization charge of $10,000.
- Depletion: Applied to natural resources such as timber and oil, depletion allocates extraction costs based on resource consumption.
Non-Recurring Charges
Non-cash charges may also represent one-off losses due to factors like accounting policy revisions, corporate restructuring, changes in asset market value, or updated cash flow assumptions. For example, General Electric’s $22 billion goodwill impairment charge in 2018 due to its power business and prior acquisitions.
Special Considerations
While non-cash charges reduce reported earnings and potentially affect share prices, companies often adjust reported earnings to exclude their influence. Investors should gauge whether such charges indicate sound accounting practices or possible red flags like poor management or rapid financial downturns.
Related Terms: write-down, earnings, accrual basis accounting, income statement, balance sheet.
References
- General Electric. “GE Announces Third Quarter 2018 Results”, Page 1.
- General Electric. “Edited Transcript: Q3 2018 General Electric Co Earnings Call”, Page 4.
- General Electric. “GE Completes Acquisition of Alstom Power and Grid Businesses”.
