Depreciation, as shown in the example, is a non-cash expense that reduces pre-tax income but increases cash flow from operations due to the tax shield. This statement is true or false?

• A. True
• B. False
• C. It reduces cash flow
• D. It increases total debt

Answer: (A)

Depreciation is a non-cash expense that lowers pre-tax income, which reduces taxes owed. That tax saving creates a cash “shield,” meaning the company keeps more cash than it would without the depreciation. On the cash flow statement, depreciation is added back to net income to convert accrual-based earnings to cash flow from operations, so it increases operating cash flow even though net income falls. The statement is true because the non-cash charge itself doesn’t bring in cash, but the tax savings it enables raise the cash generated by operations.