What is the difference between amortization and capitalization in business?

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ncchemist's profile pic

ncchemist | eNotes Employee

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Both amortization and capitalization are terms that are utilized in business and finance/accounting.  Let's look at them one at a time.

Amortization is the process of spreading a large payment out over a longer period of time.  The classic example that most people are familiar with is a home mortgage.  Very few people can afford to simply write a check that large, so amortizing the payment on a fixed schedule over a period of years allows people to purchase a home.  If the interest rate is fixed, then the payment will be the same each month for the life of the loan, thus making it much easier to do some financial household planning.  The percentage of each monthly payment that is the principal reduction versus interest changes each month, however, with the percentage going to interest decreasing steadily over time.

Capitalization can have a few different meanings but I suspect what you are looking for has to do with accounting for capital asset costs.  A capital asset is a tangible good with inherent value that a business uses to ultimately help make a profit.  When a business makes a large capital investment (like buying an expensive piece of equipment), they usually don't just write the entire purchase as a single enormous expense for a given fiscal year.  Instead, they spread the accounting of the cost out over a longer period of time.  They can do this because when they purchase the equipment it doesn't automatically just remain a big liability.  Instead, they utilize the asset to help them make money.  Ideally, the new asset will give the company the ability to earn money that they wouldn't have been able to make without it.  Also, the value of the equipment will lower over the years with use and wear.  So capitalization allows a business to make a major asset purchase and still show a profit at the same time as it puts the new asset to use.

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StephanieRR's profile pic

StephanieRR | Student, Undergraduate | (Level 1) Valedictorian

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Amortization is a term that is actually applied to two processes in business. For both processes, multiple payments are spread over time. The first process is amortization in loans, where the loan is distributed in multiple installments, and the repayment is split between the principal (money originally loaned) and the interest (extra fee charged for the use of the principal). The other process is amortization in expenses, where deductions are made to capital expenses ("money spent on buildings, machinery or equipment as an investment to increase efficiency or production over a period of time," meaning they have future value). This is done by calculating the cost of the purchase and subtracting the residual value (future good) of less tangible assets, such as patents or copyrights. "For example, if a company has spent 30 million dollars on any equipment [capital expense], and the patent [intangible asset] had lasted for 15 years, then the amortization expense will be two million dollars per year."

Capitalization is not, as the term might lead one to believe, about ow much capital a company owns.Instead, it is the measure of a company's total value. It is the sum of a company's stock, its retained earnings, and its long-term debt.

"Put simply, a business's market capitalization is equal to the number of shares outstanding, or the number of shares purchased or available for purchase, multiplied by the market price for those shares. So, if a company had a total of 100,000 shares outstanding and those shares are $5 each, the business's market capitalization would equal $500,000."

The higher the capitalization, or "cap," the more value the business has. The categories for businesses are mega-cap, large-cap, nano-cap, and micro-cap. Companies rely on their capitalization to develop their projects and products, and it also lets them determine how to expand their funding.

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adyfrancis's profile pic

adyfrancis | eNotes Newbie

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Capitalization is used on assets that are expenses that will benefit a business in generating profit in time. Amortization is applied when taking into account the depreciation of an asset over time. Amortization is dubbing each portion of the value of an asset in its period of usage as an expense.  

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