If depreciation expense is not a cash flow, why do we have to subtract it and add it back? Why not just ignore it?

Depreciation expense is a non-cash expense that reduces a company's earnings on its income statement. However, because it is a non-cash expense, it does not reduce the company's cash flow. This is why it is added back in the cash flow statement.

Here's a step-by-step explanation:

1. Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. It represents how much of an asset's value has been used up.

2. When calculating net income on the income statement, depreciation expense is subtracted because it is an expense that reduces profits. However, it's important to note that it doesn't involve any actual cash outflow.

3. When we move to the cash flow statement, we start with net income. But since depreciation expense was a non-cash deduction from net income, we add it back in the cash flow from operations section. This is because the cash flow statement is designed to show actual cash inflows and outflows, not non-cash transactions.

4. So, we subtract depreciation in the income statement to show the reduced earning due to asset usage, and we add it back in the cash flow statement to correct for the fact that it's not a cash outflow.

5. Ignoring depreciation would overstate net income and not accurately represent the wear and tear on the company's assets. It would also overstate the cash flow from operations, as it would not account for the fact that at some point, the company will likely need to replace those assets.