Question

1*Explain the importance of depreciation in estimating operating cash flow. Explain why we add it back to earnings before taxes.

Answer 1

Importance of depreciation in estimating operating cash flows

1) depreciation is a non cash expense. As it is a expense we deduct it from profits for tax purposes but in reality we need not pay for depreciation so it is not a cash expenses. Buy tax is calculated on profits less depreciation. So after calculation of profit after tax for arriving at operating cash flow we add noncash expenses in which depreciation is a part

Calculation is as below

Operating profit

Less depreciation

= EBT

less tax

= PAT

add non cash expenses

= Operating cash flow