In Equity Analysis how can depreciation be seen as a source of funds?

Question

In Equity Analysis how can depreciation be seen as a source of funds? Thx, Sandip

Answer 1

Depreciation is an accounting and tax tool. It does not effect cash flow. So if the company earns 10 million and has 2 million of depreciation, the cash flow of the company is actually increased by that 2 million. Other items being ignored, the company actually has 12 million to work with. Depreciation is somewhat misleading as there is more to the equation than just that. Depreciation is used to amortize the cost of capital investments. If however you invest 1 million in a piece of equipment, and when that equipment wears out you have to replace it with a 2 million piece of equipment or even worse the 1 million piece of equipment becomes obsolete (computer hardware) but the government will not let you depreciate the darn stuff as fast as it becomes obsolete there becomes a serious financial problem.

Answer 2

Depreciation is also a non cash entry meaning it is expensed without any cash actually going out as expenses. This helps in lowering the tax burden of the company. So in the Cashflow statement which is prevelent in American GAAP accounting practices depreciation is considered as a Source of fund and is added back to the Net Income.

Answer 3

It may be different in America, but most tax laws will not allow you to deduct a full expense all at once. It is depreciated over maybe 3 years time. But this allows you each year to deduct a portion of the expense off your taxes. This increases your refund or reduces your money owed for these years - same as cash in hand.

Answer 4

From what I remember depreciation will be deducted from original value so whatever it's value after depreciation will then be counted as an asset so that will be calculated as funds check out the inland revenue site or customs and excise