Why is the depreciation added back ?

The depreciation is added back as it is a non-cash expense or in other words it can be understood as follows

When the company purchases an asset, it is spending the entire amount to buy it at a single point of time, but in accounting it only takes the depreciation into account, therefore while calculating the FCFE we subtract the capex of the company and also depreciation. In order to account for that depreciation which was subtracted above add it back.

Why are other non-cash expenses like bad debts not added back

They are not added back because they are already accounted for in the working capital. Whenever we have bad debts, we treat them as expenses and reduce an equivalent amount from the accounts recievable, thereby netting the whole thing. Therefore there is no need to add back these expenses.

Working

Operating Income	20 cr
Operating expenses(Inclusive of losses due to bad debts and depreciation):	16cr
Net operating Income (EBIT)	4cr
Interest expense	50lkh
PBT	3.5cr
Tax rate	40% (Marginal tax rate)
PAT	2.1cr
Less:Changes in working capital(Current assets - current liabilities) = Debtors+Inventory-Bad debts-current liabilites)	30lk
Less:Net Capex	50lkh (Capex-depreciation)
Therefore the FCFE becomes	1.3cr

There are two things that we must note here:

• Depreciation has not been added back explicitly because, it was present in the net capex already and when we subtracted net capex deprecation was effectively added back


• The same is the case with bad debts, when we subtracted working capital changes, the bad debt effectively was added back