Why is depreciation added back to cash flow from operations?

Why is depreciation added back to cash flow from operations?

• A. Because it is a cash outflow.
• B. Because it increases taxes.
• C. Because it increases revenue.
• D. Because it is a non-cash expense.

Answer: (D)

Depreciation lowers reported net income but does not involve an actual cash outflow in the period. When you calculate cash flow from operations, you start with net income and add back non-cash charges to convert from accrual accounting to cash terms. Since depreciation is a non-cash expense, it’s added back to net income to reflect the true cash generated by operating activities. It may reduce taxes via a tax shield, but the cash effect of that shield is captured in taxes paid, not in the depreciation add-back itself. This is why depreciation is added back.

Depreciation lowers reported net income but does not involve an actual cash outflow in the period. When you calculate cash flow from operations, you start with net income and add back non-cash charges to convert from accrual accounting to cash terms. Since depreciation is a non-cash expense, it’s added back to net income to reflect the true cash generated by operating activities. It may reduce taxes via a tax shield, but the cash effect of that shield is captured in taxes paid, not in the depreciation add-back itself. This is why depreciation is added back.