If depreciation increases by $10, walk me through all 3 statements.

Assume a 25% tax rate. I'll go statement by statement.

Income statement. Depreciation of $10 hits the income statement as an operating expense — either inside COGS or as a separate D&A line, depending on the company. Either way, EBIT goes down by $10. Taxes go down by $10 times 25% equals $2.50. Net income goes down by $10 minus $2.50 equals $7.50.

Cash flow statement. Start with net income, which is down $7.50. Add back the $10 of depreciation as a non-cash charge in operating activities. The net effect on cash from operations is positive $2.50 — net income down $7.50 but D&A add-back of $10. No other line items move. So cash goes up by $2.50.

Balance sheet. On the asset side: cash is up $2.50, PP&E is down $10 (depreciation reduces the carrying value of the asset). Net change to assets is negative $7.50. On the liabilities and equity side: retained earnings is down $7.50 because net income flowed in at negative $7.50. Net change to liabilities plus equity is negative $7.50. Both sides match — the balance sheet balances.

The key insight is that depreciation creates a tax shield. Higher depreciation means lower reported net income but actually higher cash, because the tax savings are real cash that doesn't have to leave the company. That's why CapEx-heavy businesses optimize for accelerating depreciation where allowed — bonus depreciation, MACRS schedules — and why a depreciation step-up in an asset deal is meaningful for the buyer.

This is the most common interview question because it tests whether you actually understand the linkages or just memorized the formulas.