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Does adding back Section 179 ‘depreciation’ overstate global cash flow?

Your question:

Several of our analysts believe that 179 deductions should be treated like depreciation because it is an election to take the expense rather than capitalize the expenditure and depreciate the asset over time. I disagree and believe that adding it back may overstate cash-flow. What do you think?

Linda says:

You have stumbled across the weakness in adding back ANY depreciation…that even though depreciation does not represent an outlay of cash, they DO pay for the equipment, vehicles and the like. It takes cash out flow at some point.

If the equipment, vehicle or building is financed, depreciation does not represent cash outlay at all except for any down payment. And since we count the debt payments against them, we really would be double-dinging them if we did not add back depreciation.

But that is true no matter what type of depreciation they use…straight-line, MACRS or the first-year write-off afforded by Section 179.

Section 179 is simply an election to take a much higher amount of depreciation in the year of purpose, up to $250,000 in 2009. It has nothing to do with whether the purchase was paid for with cash or financed. So I could pay $10,000 down on a $200,000 piece of equipment and write-off under Section 179 the full $200,000.

That said, this is true even if I use ‘normal’ depreciation.

So I would not treat regular depreciation one way and Section 179 another way. I would, if it is significant, consider if the item purchased is financed. If so, and the down payment is not substantial; or if it is an unusual purchase and I am predicting recurring cashflow going forward, I’d add back depreciation.

Only if the expenditures are significant, recurring and not financed would I hold back adding back depreciation. I have heard this is true, for example, with Lew Rents or whatever you have down where you live where you can go rent a riding lawn mower or a chain saw. If those companies buy all of the equipment they rent to customers out of cash flow, clearly it would be misleading to add back deprecation.

About the Author
Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis. She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans. Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.