What is a Non-Cash Charge?
Let me explain what a non-cash charge is: it's a write-down or accounting expense that doesn't involve any cash payment. These charges can signal important shifts in a company's financial health, impacting earnings without touching short-term capital. You'll see common ones like depreciation, amortization, depletion, stock-based compensation, and asset impairments—they cut into earnings but leave cash flows untouched.
Key Takeaways
- A non-cash charge is a write-down or accounting expense that does not involve a cash payment.
- Depreciation, amortization, depletion, stock-based compensation, and asset impairments are common non-cash charges that reduce earnings but not cash flows.
- Non-cash charges are necessary for firms that use accrual basis accounting.
Understanding a Non-Cash Charge
You can find non-cash charges right in a company's income statement. These are charges without a cash outflow that must be recorded, and they're essential if the company uses accrual basis accounting—a method for logging financial transactions regardless of whether cash has actually changed hands.
Accrual Accounting
In accrual accounting, expenses like depreciation, amortization, and depletion spread out over an asset's useful life, even though the cash was paid upfront. If the initial profit didn't fully account for that cash outlay, it gets reflected across later periods. These charges hit accounts on the balance sheet, lowering the value of those items.
Take depreciation: when a company buys new equipment, you deduct a percentage of the purchase price each year over the asset's life to account for wear and tear. That shows up annually as a non-cash charge on the income statement.
Amortization works much like depreciation but for intangible assets like patents, trademarks, and licenses, not physical ones. Say a company drops $100,000 on a patent good for a decade—you record $10,000 in amortization expense each year.
Depletion allocates the cost of pulling natural resources like timber, minerals, or oil from the earth. Unlike depreciation or amortization, which deal with aging equipment or property, depletion tracks the actual physical reduction of those resources by the company.
Non-Recurring Charges
Non-cash charges can also capture one-time accounting losses from shifts in balance sheet items. These often stem from accounting policy changes, corporate restructuring, fluctuating asset market values, or revised assumptions about future cash flows.
A prime example is General Electric's $22 billion write-down of its struggling power business in October 2018, called a goodwill impairment charge. Goodwill hits the balance sheet when an acquisition tops the fair value of what's acquired, and it gets impaired later if those assets' value drops below expectations. GE's charge, largely tied to its $10.6 billion buy of Alstom in France, certainly turned heads.
Special Considerations
Non-cash charges, much like other write-downs, cut into reported earnings and can drag down share prices. Companies frequently downplay them, especially the one-off types, by adjusting earnings to strip out their effects from key financial metrics.
As an investor, it's up to you to figure out if these non-cash charges spell trouble. Many are routine and pre-announced, posing no real threat. But others might pop up unexpectedly, acting as warning signs of sloppy accounting, bad management, or a sharp downturn in the company's prospects.
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