How $10 of Depreciation Moves the Three Financial Statements

If you search for this question, you'll find it answered a dozen different ways with a dozen different final numbers. One source assumes a 25% tax rate and gets net income down $7.50. Another assumes 40% and gets net income down $6. A third skips the tax rate assumption entirely and just says "net income falls." None of them explain that the specific dollar figure was never really the point, and that's exactly the gap this guide fills. Get the pattern instead of a memorized number, and it stops mattering what tax rate or what dollar amount an interviewer throws at you.

Why This Exact Question Comes Up So Often

Real interview reports on Glassdoor show this question showing up almost verbatim at banks like UBS and Boeing's corporate finance group, and it shows up in some form at nearly every bank that runs a technical round. Interviewers like it because a single, small number touches all three statements at once, which makes it fast to ask and hard to fake your way through. If you don't actually understand why depreciation is non-cash, or why an expense going up somehow makes cash go up too, this question finds that gap in about fifteen seconds.

We've walked through the base case in detail in our guide to the three financial statements, using a 40% tax rate. That's worth reading if you want the full statement-by-statement mechanics from scratch. This guide picks up from there and goes somewhere that one doesn't: the general formula behind the numbers, and the follow-up versions of this question interviewers ask once you've handled the standard case.

The Three-Statement Walkthrough

Here's the pattern, stated once, cleanly. Say depreciation increases by $10 and the company pays taxes at a 25% rate.

Income Statement

Depreciation is an operating expense, so operating income falls by the full $10. Pretax income falls by $10 as well. Taxes drop by $2.50, since the company now owes less on lower income. Net income ends up down $7.50.

Cash Flow Statement

Start with net income, down $7.50. Add back the $10 of depreciation, since it's a non-cash charge that never left the bank. Cash from operations ends up up $2.50.

Balance Sheet

Cash increases by $2.50. Property, plant, and equipment decreases by $10, since that's the asset being depreciated. Total assets fall by $7.50. Retained earnings falls by the same $7.50, since that's where net income landed. Both sides move down $7.50, so it balances.

The Formula Behind The Numbers

Every source that answers this question picks one tax rate and stops there, which is why the internet is full of answers that look like they contradict each other. They don't. They're all the same formula with a different number plugged in for the tax rate.

For a depreciation change of D and a tax rate of t:

• Net income moves by D × (1 - t), in the opposite direction of the depreciation change.
• Cash from operations moves by D × t, in the same direction as the depreciation change.
• PP&E moves by the full D, always, since depreciation is never tax-effected on the balance sheet.
• Cash moves by D × t, matching the cash flow statement.
• Retained earnings moves by D × (1 - t), matching net income.

Run the $10 depreciation increase through that formula at a 40% tax rate instead of 25%, and net income falls by $6, cash from operations rises by $4, PP&E still falls by the full $10, and retained earnings falls by $6. Same $10, same logic, different final numbers, purely because the tax rate changed. Once you can produce this table from the formula instead of from memory, an interviewer can hand you any tax rate, any dollar figure, and the answer takes the same fifteen seconds either way.

Three Follow-Up Variations Interviewers Like To Ask

The base case is the entry ticket. What actually separates strong answers is handling the versions of this question that don't match the standard setup.

If You're Told To Ignore Taxes

Set t to zero in the formula above and something interesting falls out: cash from operations doesn't move at all. Net income falls by the full $10, you add back the full $10 of depreciation, and the two exactly cancel. That makes sense once you see it: the entire reason depreciation affects cash from operations is the tax shield it creates. No tax, no shield, no cash impact. PP&E still falls by $10 and cash stays flat, so total assets fall by $10, matched by a $10 drop in retained earnings.

A Decrease In Depreciation Instead Of An Increase

This is the version that trips people up, because the intuitive instinct runs backwards. If depreciation decreases by $10, say because an asset became fully depreciated, net income actually goes up by D × (1 - t). But cash from operations falls by D × t. Lower depreciation means a smaller non-cash add-back, which means less of a tax shield, which means the company pays more in actual cash taxes. A non-cash expense going down makes operating cash flow worse. Naming that directly, without prompting, is usually the moment an interviewer decides you understand this rather than memorized it.

If The Company Isn't Paying Cash Taxes

Some companies carry net operating losses large enough that they owe little or no cash tax in a given year, even though they still record a tax expense on the income statement for book purposes. In that case, the cash flow statement needs a deferred tax adjustment on top of the depreciation add-back, since the book tax benefit from the depreciation increase isn't actually being realized in cash yet. That's the same book-versus-cash tax gap that shows up in our deferred tax liability guide, just running in the opposite direction. You don't need the full mechanics memorized for this question, but flagging that the standard formula assumes cash taxes are actually being paid is worth a sentence if an interviewer pushes on it.

Why This Never Touches EBITDA

Depreciation sits below the EBITDA line by definition, EBITDA is earnings before interest, taxes, depreciation, and amortization, so a change in depreciation can never move it. It moves EBIT, net income, and any multiple built off of pretax or after-tax earnings, but a valuation built on EV/EBITDA is completely indifferent to this entire question. That's a fast, correct thing to say if an interviewer asks how this affects valuation, and it's a detail a lot of candidates miss because they're focused on the statement mechanics and forget to zoom out to what it means for a multiple.

Where Most People Lose Points

The most common mistake is tax-effecting PP&E, dragging the after-tax dollar figure onto the balance sheet instead of the full depreciation amount. PP&E always moves by the full D, not by D × (1 - t). The second is answering with a single memorized number instead of stating a tax rate assumption upfront, which leaves you stuck the moment an interviewer changes the rate mid-question. The third is getting the decrease case backwards, assuming lower depreciation is automatically good for cash flow when it's actually the opposite once you account for the lost tax shield.

Where To Go From Here

The pattern here is small enough to fully internalize in one sitting, but it only sticks with repetition against different numbers and different assumptions. Offcycle has this exact question, along with the decrease case, the zero-tax case, and the surrounding three-statement scenarios it tends to travel with, built into structured flashcards you can work through by topic and difficulty.

Beyond flashcards, you get custom practice sets built around whatever you're weakest on, quizzes that test the same material a different way, and a readiness score that tracks your progress across accounting, valuation, DCF, M&A, and LBO topics so you know exactly where you stand before you walk into the room.

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