University of Central Florida (UCF) ACG2021 Principles of Financial Accounting Final Practice Exam

In the context of cash flow from operating activities, depreciation expense is added back to net income in the calculation of cash flows. This treatment stems from the fact that depreciation is a non-cash expense.

When calculating cash flow from operating activities using the indirect method, the starting point is net income, which reflects all expenses incurred during the period, including depreciation. However, since depreciation does not involve an actual outflow of cash, it must be added back to net income to arrive at the actual cash generated from operating activities. This adjustment is critical because it allows for a true representation of cash flows by eliminating the impact of accounting conventions that do not affect cash movement.

By adding back depreciation, financial analysts and accountants can provide a clearer picture of the company’s cash-producing capabilities from its operations, thereby allowing stakeholders to better assess financial health and performance.