“Walk me through $10 of depreciation across the three statements” is finance’s favorite interview question because it tests the whole machine in one move. Here’s the walk, with a 25% tax rate, slowly enough to keep.
Income statement
Depreciation +$10 → pre-tax income −$10 → tax expense falls $2.50 → net income −$7.50.
Cash flow statement
Start from net income: −$7.50. Add back depreciation (non-cash): +$10. Net effect: cash +$2.50 — and notice what that is: the tax saved. Depreciation’s only real cash effect is the tax shield.
Balance sheet
| Side | Movement | Net |
| Assets | Cash +$2.50 · PP&E (accumulated depreciation) −$10 | −$7.50 |
| Liabilities & equity | Retained earnings −$7.50 (the net income) | −$7.50 |
Both sides down $7.50 — balanced, and the story complete: a non-cash expense that reduced profit while increasing cash, the pair of facts the whole question exists to test. (The general category — items that hit income without touching cash — is covered in our non-cash adjustments guide.)
The follow-ups interviewers actually ask
“What if tax rate is zero?” Net income −$10, cash flow 0 (the −10 and +10 cancel), balance sheet: PP&E −10, retained earnings −10. No tax shield, no cash effect. “Which statement would you pick to assess a company, if only one?” The cash flow statement — this very question just demonstrated why income alone misleads. Answering the walk and the follow-ups calmly is the difference the question is designed to detect.
FAQ
How does $10 of depreciation affect the three statements? Income statement: net income −$7.50 at a 25% tax rate. Cash flow: −7.50 net income +10 add-back = +$2.50 cash. Balance sheet: assets −$7.50 (cash +2.50, PP&E −10) matching retained earnings −$7.50.
Why does cash increase when depreciation rises? Depreciation itself moves no cash — but it reduces taxable income, and the tax saved (+$2.50 here) is real cash.
What happens with a 0% tax rate? No tax shield: net income −$10, zero cash effect, PP&E and retained earnings each −$10.
Why do interviewers love this question? It tests whether the three statements connect in your head as one system — accrual profit, cash reality, and the balance that ties them.