Why does depreciation impact the cash balance if it is a non-cash expense?

• A. It increases cash flow from operations
• B. It is tax deductible, reducing the amount of taxes paid
• C. It directly increases total assets
• D. It affects financing activities

Answer: (B)

Depreciation is categorized as a non-cash expense because it does not require an immediate cash outflow when recorded. However, it has a significant impact on the cash balance primarily because it is tax-deductible. When a company records depreciation on its financial statements, it reduces the taxable income, leading to lower tax liabilities. This reduction in taxes translates into cash savings for the business, thereby enhancing its cash flow from operations.

For instance, if a company has a taxable income of $100,000 and a depreciation expense of $20,000, the taxable income is reduced to $80,000. Consequently, the taxes owed—say at a rate of 25%—will be less, resulting in a direct benefit to the cash balance that the company can utilize for operational purposes or investments. This dynamic showcases how a non-cash expense like depreciation can ultimately bolster the cash position of the company through tax savings.