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Studying for a test? Prepare with these 3 lessons on Accounting and financial statements.

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# Depreciation in cash flow

Video transcript

Let's see if we can better understand what a cash flow statement for my simplified shipping truck example company would actually look like. Now I say it's simplified because this is a very simplified income statement for each of these periods. I'm not really showing all the expenses or all of the details that you would actually have for a shipping company but we really just care about the accounting. So let'a just say that at the beginning of this fiscal year, when I started this company, I had $60,000. We know from our example that we used that $60,000 to buy a $60,000 truck. And on the cash flow statement you express that saying "I spent $60,000 on Capital Expenditure" sometimes it's "property plant and equipment". So you would actually put the $60,000 right over here, on capital expenditures. and hopefully we'll understand this in a little bit Now remember, the cash flow statement is really a way of reconciling the profit with the starting and the ending cash. So let's just think about this a little bit. Our profit here, if we just take the number that we have here, Our profit in the first period is $30,000. We're assuming nothing shady is happening with the Accounts Payable, Accounts Receivable, that they're not changing over the course of the year. And then we have depreciation, and we want to think a little bit in this video, what does the depreciation do to the cash flow statement? So I'll just write down the number first. So we have this depreciation value. This is the truck depreciation. It's not just the expent value of the truck, we're spreading that cost over 3 years. So $20,000 over 3 years is the life of that truck. So the depreciation in each of these periods is $20,000. And what I'm going to show you here is, To figure out the cash from operations from actually how much cash the operations are producing. We want to add back this depreciation to the profit so our cash from operations is going to be $50,000. And it might not seem obvious to you at first, but I want you to think about it. This $20,000 that we're showing as an expense in every period, and it actually might be more obvious if we think about period 2 or period 3 We're showing it as an expense but $20,000 did not go out of the door in year 2, or year 3. We're just showing some of the expense from previous years. So no cash went out of the door. So in any of these periods, the depreciation expense should be added back to the operating profit, to figure out the cash from operations. And you might say "Wait! But we spent that $60,000, especially in year 1" And that goes here, under Capital Expenditures. The operations didn't push that cash up, the business itself, this is just an investment that we made. So it all works out, because what we see is that we got $50,000 cash from operations, and that makes sense because our revenue was $100,000 just the labor, the cash labor, people's salaries, were $50,000 So that's $50,000 of profit. This was not a cash expense, so from our operations we had $50,000 dollars, But then we did have the capital expenditures of $60,000 for the actual truck. So our ending cash would be $60,000+$50,000-$60,000. So our ending cash is going to be $50,000 Now it might make a little bit more sense if we go to the next period. Our starting cash here is $50,000. It's our ending cash of the previous period. Our profit, once again, is $30,000. You add the profit to the depreciation, you get a $50,000 operating profit same as the previous year. Or I should say cash form operations, and that makes sense, because our operations really haven't changed. We have a very, very steady business. But this year, I have no capital expenditures. So I'm using the same truck as last year. So now Our ending cash: Our starting cash was $50,000, we had $50,000 from operations, now our ending cash is $100,000. So hopefully that gives you a sense of why we add back depreciation when we figure out the cash from operations and how it works out in our cashflow statement.