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Depreciation can have a significant impact on your business's cash flows. While it is not a cash expense, it does influence your company's financial health. This is why we've compiled this short guide to depreciation and its impact on cash flow.
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Depreciation - explained
Depreciation refers to assets losing value over time. As a concept in accounting, depreciation spreads the cost of a tangible asset over the period of its useful life. Almost all fixed assets suffer from depreciation in their asset values (eg machinery, computing equipment, office supplies, IT, etc). Calculating depreciation can inform a better understanding of the depreciation expenses and costs for your business. Replacement or repair of assets is not necessarily part of revenue projections, sot o calculate depreciation means to understand more about the future costs of doing business. Also, depreciation is tax-deductible.
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Depreciation and cash flow
While depreciation is a non-cash expense, it impacts your overall financial position and cash balance. Depreciation changes your business's tax liabilities and thereby reduces cash outflows from income taxes. When you are preparing your income tax return, a depreciation expense will be listed. This then reduces the taxable income, thereby reducing cash outflows. This effect can be increased through the use of accelerated depreciation methods, such as double-declining depreciation. These methods increase the amount of depreciation that is tax-deductible. If your income increases due to more tax deductibles, it will have a positive effect on your net income and cash flow statement.
This positive effect of depreciation on cash balances is of course counteracted by the fact that depreciation only occurs with fixed assets and therefore is weighed out by the cash outflow when purchasing the fixed asset.
Depreciation is shown on your cash flow statement and income statement as well as your balance sheet. As a non-cash expense, depreciation needs to be added back to the cash flow statement in the operating activities section, alongside other expenses.
