Question

When calculating cash flow, why is depreciation first subtracted but then added back in?

Answer 1

Step-by-step explanation:

Depreciation is subtracted from net income when calculating cash flow because it is a non-cash expense. Depreciation represents the gradual reduction in value of a fixed asset over time, such as a piece of equipment or a building. This reduction in value is recorded as an expense on the income statement, but it does not involve any actual outflow of cash.

However, when calculating cash flow, it is important to consider the actual cash flows that occurred during the period being analyzed. This includes not only cash inflows, such as revenues, but also cash outflows, such as payments for expenses.

Because depreciation is a non-cash expense, it is subtracted from net income to calculate cash flow from operations. However, it is then added back in because the company still needs to replace the fixed assets that are being depreciated. When a company replaces a fixed asset, it will typically incur a cash outflow in the form of a payment for the new asset. This cash outflow is then included in the calculation of net cash flow from investing activities.

By subtracting and then adding back in depreciation when calculating cash flow, the resulting cash flow statement reflects both the non-cash expense of depreciation and the actual cash outflows for replacing fixed assets. This provides a more accurate representation of the company's cash flow situation.

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Answer 2

Step-by-step explanation:

In accounting, depreciation is the process of allocating the cost of a long-term asset over its useful life. Depreciation is used to reflect the wear and tear or obsolescence of an asset over time.When calculating cash flow, depreciation is subtracted first because it represents a non-cash expense. This means that although depreciation is recorded as an expense on the income statement, it does not represent an actual cash outflow. Therefore, it is subtracted from the net income in order to calculate the cash flow from operating activities.However, depreciation is then added back in because it represents a reduction in the value of an asset. When an asset is sold or retired, the proceeds from the sale or the value of the asset at the time of retirement are used to offset the accumulated depreciation. Therefore, in order to accurately reflect the change in the value of the assets, depreciation must be added back in.