Why does depreciation affect cash balance if it is a non-cash expense?

• A. Depreciation is tax-deductible. Since taxes are a cash expense, depreciation affects cash by reducing the amount of taxes you pay.
• B. Depreciation increases cash directly.
• C. Depreciation has no impact on cash flow.
• D. Depreciation only affects the balance sheet.

Answer: (A)

Depreciation creates a tax shield: it is deductible for tax purposes, so it lowers taxable income. Lower taxable income means lower taxes owed, and since taxes are paid in cash, this reduces cash outflows and leaves more cash on hand. Even though depreciation itself doesn’t involve an actual cash outlay, the saving on taxes is a real cash benefit, which is why depreciation can improve the cash balance. In the cash flow statement you’ll see depreciation added back to net income because it’s a non-cash expense, but the genuine cash impact comes from the reduced tax payment. The other ideas miss that the direct cash gain comes from tax savings, not from depreciation itself, and that depreciation does influence cash flow beyond the balance sheet.