“Depreciation goes up by $10”: walking through the three statements

The classic banking technical, answered properly: walk me through the three statements, then what happens when depreciation rises by $10 at a 25% tax rate.

7 October 2026 · 7 min read · RoundReady

If you're interviewing for investment banking, you will almost certainly be asked “walk me through the three statements” and some version of “depreciation goes up by $10, what happens?” They're asked so often that a shaky answer stands out. A clean one buys you goodwill for the harder questions later.

The good news is that both have a fixed shape. Learn the shape, practise saying it aloud until it takes under a minute, and you'll be fine.

“Walk me through the three statements”

Interviewers want to hear three things: what each statement shows, and how they connect. Not a list of every line item.

“The income statement shows revenue, expenses and profit over a period, ending in net income. The balance sheet is a snapshot of assets, liabilities and equity at a point in time, and assets always equal liabilities plus equity. The cash flow statement starts with net income, adjusts for non-cash items like depreciation and for changes in working capital, then adds investing and financing flows to get the change in cash. Net income flows into retained earnings on the balance sheet, and the change in cash at the bottom of the cash flow statement becomes the cash line on the balance sheet.”

That's about 40 seconds spoken. Stop there and let them ask a follow-up. Candidates who keep going into deferred tax and minority interest usually make a mistake they didn't need to make.

Depreciation up $10, at a 25% tax rate

Always go in the same order: income statement, then cash flow statement, then balance sheet. And always finish by checking that the balance sheet balances. Assume the depreciation is tax-deductible unless told otherwise.

Depreciation +$10, tax rate 25%

INCOME STATEMENT Depreciation +10 Pre-tax income −10 Tax (25%) −2.5 Net income −7.5 CASH FLOW STATEMENT Net income −7.5 Add back depreciation +10 (non-cash) Cash from operations +2.5 Net change in cash +2.5 BALANCE SHEET Cash +2.5 PP&E −10 Total assets −7.5 Retained earnings −7.5 Liabilities + equity −7.5 ✓ balances

Say it in words too, because that's what they'll hear: “Operating income falls by 10. At 25% tax, net income falls by 7.5. On the cash flow statement, net income is down 7.5 but we add back the 10 of depreciation because it's non-cash, so cash is up 2.5. That 2.5 is the tax saving. On the balance sheet, cash is up 2.5 and PP&E is down 10, so assets are down 7.5. Retained earnings are down 7.5 from lower net income, so both sides fall by 7.5 and it balances.”

The one idea to say clearly is that cash goes up. It surprises people the first time, but it's just the tax shield: depreciation itself costs no cash, and it reduces the tax bill.

The variations you should have ready

Once you've answered the depreciation question, expect a twist. These are the common ones. Use the same three-step order every time.

Inventory bought for $10 cash

Buy $10 of inventory with cash

IS no change (not sold yet, so no cost of goods sold)CFS increase in inventory −10 in operating cash flow net change in cash −10BS cash −10, inventory +10, total assets unchanged ✓

An accrued expense of $10 (25% tax)

Record a $10 expense that hasn't been paid yet

IS operating expense +10 → pre-tax −10, tax −2.5, NI −7.5CFS NI −7.5, increase in accrued liabilities +10 cash from operations +2.5BS assets: cash +2.5 liabilities: accrued expenses +10 equity: retained earnings −7.5 +2.5 = +10 − 7.5 ✓

Buy $100 of equipment with debt, then one year passes

This one has two parts. At the moment of purchase: no income statement effect. On the cash flow statement, capex is −100 in investing and debt raised is +100 in financing, so cash is unchanged. On the balance sheet PP&E is +100 and debt is +100. It balances.

Then the interviewer says: “A year passes. Depreciation is 10 a year, the debt has 10% interest paid in cash, tax is 25%.”

One year later

IS depreciation +10, interest +10 → pre-tax −20 tax −5, net income −15CFS NI −15, add back depreciation +10 → cash −5BS cash −5, PP&E −10 → assets −15 retained earnings −15 → L + E −15 ✓

Debt doesn't change because only interest was paid, not principal. If you're told principal was repaid too, that's an extra financing outflow and a matching fall in debt.

Where people lose marks

Forgetting tax. Saying net income falls by 10 is the most common slip. Always ask or state the tax rate.
Starting with the balance sheet. You'll tie yourself in knots. Income statement first, every time.
Not checking that it balances. End with “both sides down 7.5, it balances.” It shows you know why the answer is right, not just what it is.
Mixing up the cash flow sign on working capital. An increase in an asset (like inventory) uses cash. An increase in a liability (like accrued expenses) provides cash.
Rambling. Each of these should take well under a minute. Long pauses or restarts suggest you're working it out for the first time.

How to drill it

Write ten scenarios on cards: depreciation up, inventory written down, a goodwill impairment, issuing shares for cash, paying a dividend, buying equipment with debt and so on. Shuffle them. Answer each out loud, timed, then check. Once you're getting all ten right in under a minute each, change the tax rate to 40% and do it again so you're not just remembering 7.5.

It also helps to fill the numbers into a simple three-statement grid as you talk. The banking track has a three-statement sheet next to the interview for exactly this, and the interviewer will ask you where each number goes rather than accepting a final answer on its own.