Final answer:
An increase in depreciation will decrease a company's reported profit but increase its cash flow. As depreciation is a non-cash expense, it does not reduce the company's actual cash reserves, allowing for potential reinvestment in growth activities if the cash flow is strong.
Step-by-step explanation:
An increase in depreciation will decrease profit on a firm's income statement because it is an expense that reduces the company's reported net income. However, it will increase cash flow since depreciation is a non-cash expense; it doesn't involve an actual outlay of cash in the current period. Hence, while the firm's profitability as shown in net income will decrease, its actual cash reserve will not be directly affected by the depreciation expense.
Businesses can reinvest their profits into various ventures such as upgrading factories, employment of additional labor, or adoption of new technology. This kind of reinvestment is essential for growth and sustainability, especially if a company's cash flow, which is pivotal in funding such activities, outpaces the depreciation costs on its equipment and facilities.
Moreover, financial capital decisions play a significant role for firms planning significant investments like purchasing machines or constructing new facilities. The ability to raise capital through investors, retained earnings, loans, or stock offerings can facilitate these investments, which are foundational for future profitability and expansion.