Notice that the change in Cash on the Balance Sheet as the result of the transaction is equal to the Cash Flow from the transaction. As we indicated above, the Cash Flow Statement summarizes the change in Cash on the Balance Sheet during the period. In this simplified business, Cash Flow 2019 = Cash 2019 - Cash 2018 The tax shelter created by depreciation often creates an accrued tax liability if the depreciation method used for taxes differs from the used for financial accounting. Note: Asking how depreciation impacts each of the Financial Statements is a common interview question to test a candidate's understanding of how Financial Statements interrelate. 2018 2019 2020 2021 2022 Income Statement Depreciation o -100 -100 Tax (30% tax rate) Net Income -100 Depreciation is included as in expense either in Cost of Revenues (depreciation of the manufacturing plant or related equipment which may include the computer) or Operating Expenses (depreciation of offices or office equipment, which may include the computer, R&D labs or warehouses) 30 Depreciation reduces taxes as a non-cash expense (a 'tax shelter'), shown here as a benefit to Net Income -70 Depreciation reduces Net Income g 0 30 -70 30 -70 Balance Sheet Cash PP&E 0 0 -300 300 The cash impact of the expenditure is recognized immediately on the Balance Sheet o CapEx increases PP&E, while Depreciation expense reduces PP&E over the life of the asset 200 100 Cash Flow Statement Net Income Depreciation Cash Flow from Operations 0 0 -70 100 30 -70 100 30 -70 Net Income is the same as the figure reported on the Income Statement 100 Depreciation, like all non-cash items recognized on the Income Statement, are recorded as adjustments to reconcile Net Income to Cash Flow from Operations 30 The tax shelter created by depreciation is the resulting benefit to Cash Flow from Operations from the investment in the computer CapEx Cash Flow from Investing -300 -300 0 o o 0 o Capital expenditures are a use or consumer of Cash o CapEx is added to the Cash Flow from Investing and Reduces Free Cash Flow Cash Flow from Financing 0 0 0 0 Total Cash Flow -300 30 30 30 The outflow of Cash to CapEx is the only cash impact recognized on the Cash Flow Statement Free Cash Flow -300 30 30 30 Required Homework Questions How would Cash Flow from Operations be different in 2019 if the computer was not paid for immediately but instead over 90 days? Recall, the transaction occurred the last day of 2019 so the cash payment would occur in 2019. (a) Cash Flow from Operations would be $300 higher because of the increase in Accounts Payable (b) Total Cash Flow would be lower by $300. (c) Total Cash Flow would be $0