Question

Agree or Disagree, and Why?

The cash flow statement is an interesting report that I understand through the years I have been doing business school, but I really never knew how to analyze it compared to other financial factors. The core purposes of the statement to see if a company can handle to their monthly bills, pay dividends, and avoid bankruptcy. Cash flow is broken up into operating activities, investment activities, and financing activities. I was interested to see all the different activities and what fell into them. The two main methods of preparing the statements are direct and indirect. The direct is a cash statement in the form of income statements, and the indirect reconciles cash from operations. The interesting thing about cash flow that I have a hard time with is the inputs of depreciation, and I really do not understand how no-cash expenses work into cash lows. The depreciation inputs really gave me trouble during the quiz problems, and I was not quite able to get them right. (Ch 13, Mark Imbrigiotta)

Answer 1

Agree.....

We know that a cash flow statement is a statement where all and only cash outflows and inflows are to be recorded, that is the reason its called cash flow statement.

in contradiction we sometimes add prevailing Non cash expenses for example DEPRECIATION, Loss on sale of asset and so on, and on the other hand we substract all the Non Cash incomes from the statement, for example: profit on sale of asset.

so the answer to your Question is,

Depreciation is a constant and gradual decrease in the value of the Asset caused by the wear and tear or obsolence of the asset, this creates an impactt on the taxation as while computing the tax you substract the value of depreciation from the value of asset which makes the asset value look smaller and the tax you pay becomes less than you would have paid in case you did not dedect the depreciation.

so basically, depreciation in cash flow statement is used to reflect the similar impact as, we know that depreciation is fund created yearly or howsoever , because we know that machine or any other fixed assest will not stay with us forever it will diminish with time rather its value will diminidh over time due to its wear and tear or obsolence and hence we find a predetermined value known as its salvage value and its life, so that we know that that after so n so years we will have to buy or replace this asset for a new one.

and for the New asset you will have to maintain funds so that you dont expend one big amount suddenly, but you plan and keep aside little little amount side side by side in the form of depreciation,which also keeps giving you tax benefits.

So, when you show depreciation in cash flow it symbolises that you are selling a part of machinery and cash is flowing in and you add it, but it is a notional transaction as in reality you arent selling any asset but instead you are keeping aside some money for the replacement of such asset.

so all in all depreciation is not a real cash expense but a notional expnse which has to shown in the cash flow statement.similary loss on sale of asset... you are not actually bearing the loss or paying for loss to reflect the cash flow it is added in the cash flow statement.