Discuss the impact of depreciation expense on the cash flow analysis of a capital project.
Depreciation is a non-cash expense that reduces the carrying value of an asset (Parker, 2021). It's
applied for a fixed asset over its useful life until it's disposed of. Depreciation is shown in the
income statement, balance sheet, and cash flow statement (Bragg, 2022). These are various
methodologies to calculate the depreciation of any fixed asset. However, the method chosen
should reflect the asset value and expense recognition.
Depreciation has a considerable effect on the overall financial performance of the company
(Parker, 2021). When we come to the balance sheet, depreciation is presented as an expense to
show the decline in value of a fixed asset. In the income statement, depreciation is presented as
an indirect operating expense and reduces the gross profit of the firm.
One of the major effects depreciation has on the cash flow of a business is by reducing income
taxes. This will lead the firm to have a higher net income that translates into higher operating
cash flow. However, depreciation doesn't have a direct effect on the cash flow created by the
firm. Another effect of fixed asset depreciation is on the return on equity of a firm. Since
depreciation decreases the value of a fixed asset it will also affect the value of equity.
Subsequently, the loss of value in assets will reduce the return on equity for the stockholders
(Parker, 2021).
Another metric that is affected by depreciation is earnings before interest taxes, depreciation, and
amortization (EBITDA). This metric can show the profitability of a company more clearly.
Many analysts use this metric to compare companies with each other or with industry standards.
It is a good indicator of the cash flow that will be available to repay the debt of long-term assets
(Parker, 2021).
Also, discuss the types of leasing arrangements and their pros and cons relating to
depreciation expense.
Leases are types of contracts where a property/asset owner gives the other party the right to use
the property/asset for a monetary exchange (Corporate Finance Institute, 2022). There are
various types of leases in accounting however the two most common types are operating and
financing (capital lease) leases.
Depreciation is a non-cash expense that reduces the carrying value of an asset (Parker, 2021). It's
applied for a fixed asset over its useful life until it's disposed of. Depreciation is shown in the
income statement, balance sheet, and cash flow statement (Bragg, 2022). These are various
methodologies to calculate the depreciation of any fixed asset. However, the method chosen
should reflect the asset value and expense recognition.
Depreciation has a considerable effect on the overall financial performance of the company
(Parker, 2021). When we come to the balance sheet, depreciation is presented as an expense to
show the decline in value of a fixed asset. In the income statement, depreciation is presented as
an indirect operating expense and reduces the gross profit of the firm.
One of the major effects depreciation has on the cash flow of a business is by reducing income
taxes. This will lead the firm to have a higher net income that translates into higher operating
cash flow. However, depreciation doesn't have a direct effect on the cash flow created by the
firm. Another effect of fixed asset depreciation is on the return on equity of a firm. Since
depreciation decreases the value of a fixed asset it will also affect the value of equity.
Subsequently, the loss of value in assets will reduce the return on equity for the stockholders
(Parker, 2021).
Another metric that is affected by depreciation is earnings before interest taxes, depreciation, and
amortization (EBITDA). This metric can show the profitability of a company more clearly.
Many analysts use this metric to compare companies with each other or with industry standards.
It is a good indicator of the cash flow that will be available to repay the debt of long-term assets
(Parker, 2021).
Also, discuss the types of leasing arrangements and their pros and cons relating to
depreciation expense.
Leases are types of contracts where a property/asset owner gives the other party the right to use
the property/asset for a monetary exchange (Corporate Finance Institute, 2022). There are
various types of leases in accounting however the two most common types are operating and
financing (capital lease) leases.
