How depreciation flows through the three financial statements

The answer, in 30 seconds

1. Income statement: operating profit falls £10. At a 25% tax rate, tax falls £2.50, so net income falls £7.50.
2. Cash flow statement: start from net income (−£7.50) and add back the £10 of depreciation, because no cash left the business. Cash rises £2.50.
3. Balance sheet: PP&E falls £10 and cash rises £2.50, so assets fall £7.50. Retained earnings fall £7.50. Both sides fall by £7.50, so it balances.

Why cash goes up

Depreciation is an accounting charge, not a payment. It does reduce taxable profit, though, so the company pays £2.50 less tax. That tax saving is the only real cash effect, which is why cash rises even though profit falls.

Mistakes interviewers listen for

• Forgetting tax, which gives net income −£10 and cash unchanged.
• Saying cash falls by £10. No cash is spent on depreciation itself.
• Not stating your tax rate. Say "assuming a 25% tax rate" at the start: it's the current UK main rate, and stating assumptions sounds like a banker.

How to say it out loud

Go statement by statement, always in the same order (income statement, cash flow statement, balance sheet), and finish by confirming that it balances. Interviewers care as much about that structure as about the numbers.