Depreciation allocates the cost of a physical asset — equipment, vehicles, furniture, leasehold improvements — across the years it will be used. A 1,500 per year under straight-line depreciation: each year, $1,500 appears as an expense on the income statement, reducing reported profit, while the asset’s book value on the balance sheet decreases by the same amount.
Depreciation is a non-cash expense — no money leaves the business when depreciation is recorded. The cash was spent when the asset was purchased. This is why the cash flow statement adds depreciation back to net income when calculating operating cash flow: it reduces reported profit but not actual cash.
Common methods: straight-line (equal amounts each year), declining balance (more in early years, less later), and Section 179 / bonus depreciation (deduct the full cost in the year of purchase, subject to IRS limits — often used by small businesses to accelerate tax deductions).