Walk me through how depreciation going up by $10 would affect the three financial statements
Answer
In short, I would coherently explain the flow from left to right.
Sample Answer:
Income Statement
Operating Income would decline by $10 and assuming a 40% tax rate, Net Income would go down by $6
CF Statement
The Net Income at the top goes down by $6 but the $10 Depreciation is a non-cash expense so overall Cash Flow from Operations goes up by $4. There are no changes elsewhere so the overall net change in cash increases by $4
Balance Sheet
PP&E goes down by $10 on the Assets side because of the Depreciation and Cash is up by $4 from the changes on the CF statement
Overall
Assets down $6. Since NI fell by $6 as well, SE is down by $6 and both sides of the Balance Sheet balance
Why this matters to bankers
Similarly to the above, understanding depreciation is a key to understanding how the statements link together. Since depreciation is a non-cash expense, it requires a strong understanding of each statement to correctly account for it. It’s commonly tested and should be locked down.