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How Does Depreciation Affect Cash Flow?

Sarah Jenkins • Sep 30, 2026 • 5 min read

Depreciation is an accounting concept that acknowledges the wear and tear, aging, or obsolescence of an asset over time. It represents the decrease in the value of an asset as it is used for business operations. While depreciation does not directly impact cash flow, it indirectly affects it by influencing several financial aspects of a company. In this article, we will explore how depreciation impacts cash flow and address related FAQs.

Depreciation and Taxes

One of the key ways in which depreciation affects cash flow is through its impact on taxes. Businesses are permitted to deduct a portion of their asset’s depreciated value from their taxable income. This deduction, known as depreciation expense, reduces the company’s tax liability, resulting in a lower cash outflow for taxes. A lower tax burden implies higher cash flow.

FAQ 1: How does depreciation lower taxes?

Depreciation lowers taxes by reducing the taxable income of a business. As the asset depreciates, the depreciation expense is deducted from revenues, thus reducing the amount of profit subject to taxation.

FAQ 2: Can I claim depreciation on all assets?

No, not all assets are depreciable. Generally, tangible assets such as buildings, equipment, machinery, and vehicles are eligible for depreciation, while intangible assets like patents and copyrights are not.

FAQ 3: How is depreciation expense calculated?

Depreciation expense can be calculated using various methods, such as straight-line depreciation or accelerated depreciation methods like the double-declining balance method.

Depreciation and Cash Flow Statement

While depreciation does not directly affect overall cash flow, it impacts the cash flow statement in two significant ways. Firstly, depreciation is added back to net income in the operating activities section of the cash flow statement as it is a non-cash expense. Secondly, depreciation is included in the calculation of cash flow from investing activities when purchasing new assets.

FAQ 4: Why is depreciation added back to net income in the cash flow statement?

Depreciation is added back to net income to reflect that it is a non-cash expense. Since depreciation is simply an accounting entry, it does not involve any cash outflow.

FAQ 5: How does depreciation affect cash flow from investing activities?

When a company purchases new assets, the cash outflow is recorded in the cash flow from investing activities section. The cost of the new asset is reduced by the accumulated depreciation, which lowers the net cash outflow.