Which of the following describes depreciation's impact on cash flow?

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Multiple Choice

Which of the following describes depreciation's impact on cash flow?

Depreciation is a non-cash expense that reduces reported income but does not require an actual cash outlay in the period. In other words, you record it as an expense to lower accounting profit, but no cash changes hands when the depreciation is recorded. This matters for cash flow because, on the cash flow statement, you add back non-cash expenses like depreciation to net income when calculating cash from operations, reflecting that the income statement charge did not consume cash. At the same time, depreciation lowers taxable income, which reduces taxes and creates a cash savings (the tax shield), so there is an indirect positive cash flow effect through taxes, even though the depreciation line item itself is non-cash. The statement that best captures the direct effect is that depreciation reduces reported income but does not affect cash flow in the period, since the cash impact comes from the tax shield rather than the depreciation expense itself. Depreciation isn’t a cash flow item tied to debt, and purchasing equipment is a cash outlay at purchase, not an effect of depreciation.

Depreciation is a non-cash expense that reduces reported income but does not require an actual cash outlay in the period. In other words, you record it as an expense to lower accounting profit, but no cash changes hands when the depreciation is recorded. This matters for cash flow because, on the cash flow statement, you add back non-cash expenses like depreciation to net income when calculating cash from operations, reflecting that the income statement charge did not consume cash. At the same time, depreciation lowers taxable income, which reduces taxes and creates a cash savings (the tax shield), so there is an indirect positive cash flow effect through taxes, even though the depreciation line item itself is non-cash. The statement that best captures the direct effect is that depreciation reduces reported income but does not affect cash flow in the period, since the cash impact comes from the tax shield rather than the depreciation expense itself.

Depreciation isn’t a cash flow item tied to debt, and purchasing equipment is a cash outlay at purchase, not an effect of depreciation.

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