Question

While conducting an operating cash flow analysis for your firm, you asked your Administrative Assistant to prepare the documents in Excel. As part of that process, the assistant notes that they don't understand why depreciation is important- as it is always considered a non-cash expense. Prepare a written answer for your assistant, clearly explaining the managerial implications depreciation on operating cash flow.

Answer 1

Depreciation is a non-cash expense but depreciation provides income tax shield. Since tax payment is cash outflow, depreciation reduces this cash outflow. Depreciation by itself is a non-cash expense but it helps in saving cash flows due to tax shield. The depreciation policy can increase or decrease the cash flow in the short term or long term. Hence Depreciation is very essential for calculating operating cash flows. Mangers must always include the correct depreciation and follow straight line method, reducing balance method or MACRS method of depreciation calculation which provides the benefits to the company.


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