Depreciation is a non-cash expense that represents the reduction in the value of an asset over time due to wear and tear or obsolescence.
It is recorded on the income statement to allocate the cost of a tangible asset over its useful life.
While depreciation does not involve direct cash outflow, it is treated as a use of funds in financial analysis because it reduces net income.
Any activity or expense that reduces net cash, net profit, or retained earnings is considered a use of funds. Depreciation indirectly reduces the profit available for distribution or reinvestment.
Additional Information:
Impact of Depreciation on Financial Statements:
Income Statement: Recorded as an expense, reducing net income.
Balance Sheet: Accumulated depreciation is subtracted from the asset's original cost, lowering book value.
Cash Flow Statement: Added back to net income in operating activities because it is a non-cash expense.
Methods of Depreciation: Straight-Line Method, Declining Balance Method, Units of Production Method.
