Methods of amortization calculation with formulas
A few things have already been mentioned above about the methods of amortization calculation. In the following we will show you what the individual formulas look like and which individual quantities the formulas must contain. You will also find out which relevant data you have to work with for the respective methods.
Average method – static amortization calculation
Formula for the calculation:
Payback period in years = initial capital investment / return flow per period
The individual quantities of the formula:
- The initial capital investment is represented by the acquisition or investment costs
- Return flow per period is derived from profit per period by deducting imputed depreciation and imputed interest
Relevant data for the average method:
- Capital investment
- Profit per year
- Plus imputed depreciation
- Plus imputed interest
- Reflux per period
Accumulation method – dynamic amortization calculation
According to dictionaryforall.com, the special feature of this method is that the time of the return flow is taken into account for the amortization calculation. So there are no averages for the calculation. The individual values for the return flow, consisting of profit and depreciation, are added up. And this is repeated in the following years.
- Return in the first year = profit year 1 + depreciation year 1
- Cumulative return flow in year n = return flow year 1 + return flow year 2 + return flow year
Obtaining the data for the amortization calculation
Of course, you need data for the calculation so that your amortization calculation provides you with a reasonable statement. Data in formula of numbers. Therefore, it is particularly important for the data relating to tied capital, depreciation and imputed interest. You can find out what is hidden behind these individual points in the following description.
The capital tied up depends heavily on how you made your investment. This means that both the type of financing and the contract design play an important role. For example, you may have made a machine purchase through a loan or by using equity . Buying with equity is not that common these days, but it can happen. If this is the case, this capital corresponds to the purchase price at the time of purchase.
If you generate a profit from the investment at this point in time, this must be deducted from the purchase price. If the machine is financed by a loan, the amount of money required for it is higher. In this case, you also have to take the accruing interest into account. But it should also be noted that the annual installments are significantly lower than the total purchase price. And from this fact the sense of a loan is derived, namely to distribute the financial burden.
In accounting, depreciation records an impairment of assets. You have to take this into account within the dynamic amortization calculation. Depreciation means that the machine loses value due to wear and tear or technical innovations. And this reduction in value plays a very important role in the amortization calculation. In the first year you have to pay for maintenance, repairs or spare parts. This in turn has to be deducted from your profit and this is therefore reduced. In terms of payback period, this means that it will be longer. There are various types of depreciation available.
The imputed interest
Imputed interest is interest that you would have earned if you had not used your equity for the investment, but invested the capital. Simply put, it should be noted that the imputed interest on equity is the same as it is on interest on borrowed capital, which you would have to pay. All interest that has to be paid must be deducted from the profit made. And it is the same with imputed interest. Specifically, this means that if you had invested your equity well, you might have made more profit than your investment, which equates to a loss. And this is exactly what you have to pay attention to when calculating the amortization. You must subtract the lost profit on your equity from the profit on the investment.
Classification of the amortization calculation in the investment calculation
The amortization calculation is part of the applied investment calculation method. Further procedures are used within these.
- Amortization calculation
- Profit comparison calculation
- Cost comparison calculation
- Profitability comparison calculation
The differences between these calculation methods are shown as follows.
|Amortization calculation||Use of deposits and withdrawals as calculation variables. Reference is based on several planning periods. The amortization calculation is based on expected surplus payments.|
|Profit comparison calculation||The basis for calculation are costs and services. These relate to a planning period.|
|Cost comparison calculation||Calculation with costs only. Reference is a planning period.|
|Profitability comparison calculation||The basis for calculation are costs and services. These relate to a planning period.|