Understanding Depreciation: The Indirect Impact on a Company’s Cash Balance

If Depreciation is a non-cash expense, why does it affect the cash balance?

Although it is a non cash expense, Depreciation is tax deductible which means it affects your cash balance by reducing taxes.

Depreciation is a non-cash expense because it represents the reduction in the value of an asset over time due to wear and tear, obsolescence, or other factors. It is recorded as an expense in the income statement, but it does not involve an actual outflow of cash.

However, depreciation does affect the cash balance indirectly through its impact on the company’s taxes. Depreciation expense reduces the taxable income, and as a result, the company pays less in income taxes. This means that the company has more cash available to use for other purposes, such as investing in new assets, paying down debt, or distributing dividends to shareholders.

In addition, depreciation can also affect the cash balance if the company sells the asset that has been depreciated. When an asset is sold, the company receives cash for the sale, but it may also need to account for the accumulated depreciation on the asset. If the accumulated depreciation is higher than the book value of the asset (i.e., the cost of the asset minus its accumulated depreciation), it will result in a gain on the sale, which increases the company’s cash balance. Conversely, if the accumulated depreciation is lower than the book value of the asset, it will result in a loss on the sale, which reduces the company’s cash balance.

Therefore, although depreciation itself does not involve a cash outflow, it can indirectly affect the company’s cash balance through its impact on taxes and the sale of assets.

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