Why do we subtract depreciation in the calculation of EBIAT if we are going to add it back as the next step of the Free Cash Flow formula?

Depreciation on assets is recognized by tax authorities as an expense that a business actually incurs so when the income statement is calculated, depreciation needs to be removed as the expense that it is so that taxes can be calculated on the profit.

Depreciation however, does not take actual cash from the company i.e the company does not actually pay anyone cash for depreciation like most other expenses. It needs therefore to be added back to the Free Cash Flow because the FCF deals with how much actual cash the company has which is something that Depreciation being a non-cash expense did not reduce.

jayilych4real jayilych4real · Answer 2 · 2021-11-18T14:59:44+01:00

The reason why we subtract depreciation in the calculation of EBIAT if we are going to add it back as the next step of the Free Cash Flow formula is because:

Depreciation is tax deductible

According to the given question, we can see that we need to show why it is necessary to subtract depreciation when calculating the EBIAT in the Free Cash Flow formula.

As a result of this, we can see that when an asset depreciates, then according to the government, it is a taxable commodity which makes it important to remove it from the income statement so that it would be calculated together instead as a separate part.