What is a Non-Cash Charge?
A non-cash charge is a write-down or accounting expense that does not involve a cash payment. They can represent meaningful changes to a company's financial standing, weighing on earnings without affecting short-term capital in any way. Depreciation, amortization, depletion, stock-based compensation, and asset impairments are common non-cash charges that reduce earnings but not cash flows.
- 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
Non-cash charges can be found in a company’s income statement. Charges unaccompanied by a cash outflow must be recorded and are necessary for firms that use accrual basis accounting, a system used by companies to record their financial transactions, irrespective of whether a cash transfer has been made.
Depreciation, amortization, and depletion are expensed throughout the useful life of an asset that was paid for in cash at an earlier date. If a company's profit did not fully reflect the cash outlay for the asset at that time, it must be reflected over a set number of subsequent periods. These charges are made against accounts on the balance sheet, reducing the value of items in that statement.
- Depreciation: When a company buys new equipment, a percentage of the purchase price is deducted over the course of the asset's useful life to factor in things like wear and tear. That expense is recorded every year in the income statement as a non-cash charge.
- Amortization: Amortization is very similar to depreciation, but applies to intangible assets such as patents, trademarks and licenses rather than physical property and equipment. If a company spends $100,000 on a patent that lasts for a decade, it records an amortization expense of $10,000 each year.
- Depletion: Depletion is a technique used to allocate the cost of extracting natural resources such as timber, minerals, and oil from the earth. Unlike depreciation and amortization, which mainly describe the deduction of expenses due to the aging of equipment and property, depletion is the actual physical depletion of natural resources by companies.
Non-cash charges can also reflect one-time accounting losses that are driven by changing balance sheet items. Such charges are often the result of changes to accounting policy, corporate restructuring, the changing market value of assets or updated assumptions on realizable future cash flows.
General Motors Co.’s (GM) $23 billion write-down of the value of its struggling power business in October 2018, referred to as a goodwill impairment charge, is a great example of a non-recurring non-cash charge. Goodwill is added to the balance sheet when an acquisition exceeds the fair value of the acquired entity, and it must be impaired in the future if the value of the acquired assets falls below original expectations. GM’s big accounting charge, mainly linked to its $10 billion acquisition of France-based Alstom, understandably raised eyebrows.
Non-cash charges, like other types of write-downs, reduce reported earnings and, as a result, can weigh on share prices. Companies often seek to play down the significance of non-cash charges, particularly one-off ones, adjusting earnings to exclude their impact from financial figures.
Investors are tasked with determining whether non-cash charges are a cause for alarm. Non-cash expenses are often pre-flagged and harmless. However, some may appear out the blue and serve as potential red flags of poor accounting, mismanagement and a drastic shift in fortunes.