Will depreciation of assets result in reporting lower net income and higher net cash flow? Explain.?

Question

Will the Depreciation of Assets result in reporting lower net income and higher net cash flow or will Depreciation of Assets report both lower net income and lower net cash flow? I could use some clarity, Thanks danny

Answer 1

Depreciation of assets (as opposed to not depreciating them) will indeed lead to lower net income and higher cash flows.

If you have a company that pulled in revenues of $100 and had no expenses (let's say you are a Tarot Card reader out of your own home, okay?), your pre-tax income would be $100. Let's assume 10% tax rate, you're net income is $90. You bought a rare set of Tarot Cards for $300 last year. If you don't depreciate them, no change in expenses and no change to the bottom line. If you decide to depreciate them (let's say they last 6 years), you would report $50 of depreciation per year ($300/6) with no scrap value. Your revenues ($100) minus expenses ($50 depreciation) equals $50 pre-tax profits, less tax of 10% of $5 = $45.

Your operating cash flow for this year would be $90 (pre-tax profit minus tax) if you don't depreciate the cards. If you do depreciate, your cash flows are pre-tax profits ($50) minus your tax ($5) plus the non-cash items (depreciation of $50) = $95. Why is your cash flow better? You got a 10% tax deducation on your depreciation of $50, which lowered your taxes by $5.

Answer 2

Sure. Depreciation is an expense and like all expenses will lower net income. However, depreciation does not affect cash in the current period, since it has to do with something you purchased in an earlier period.

So the right answer is it lowers net income with NO effect on cash flow.

Answer 3

You should really be doing your own essay. But if it helps. Depreciation will result in lower net income. It does not affect cash flow in the immediate term as there is no cash outlay. However, once the asset has passed its effective life it will need to be replaced thereby resulting in a cash outlay; either outright or over a period of years if finance is used to obtain the new asset.

Answer 4

Lower net income. It is viewed as an expense you incurred throughout the year. It reduces your taxable income. However, if you have no income... it's tough to get any depreciation benefits.