Cash flow after tax
Cash flow after tax (also called after-tax cash flow or CFAT). Your business's cash flow is simply after deducting all cash expenses and tax from the company's before-tax cash flow.
What is cash flow
Cash flow is the amount of cash and cash equivalents that flows in and out of a company. It includes your cash revenue (money received ) and expenses( cash spent out). A company can generate cash flow through its operation, investment, and financing ( debt and equity). A company's cash flow report can be found in its cash flow statement.
Net cash flow is the difference between a company's cash inflow and outflow. Cash flow can be positive or negative. There is a positive cash flow when a business has more money coming in than money going out.
There is negative cash flow when more money goes out than money comes in.
Note: Positive cash flow does not always mean profitability; it only tells us the business has enough cash to meet its cash obligations. Likewise, a negative cash flow does not mean you are running at a loss. In some cases, a company will have positive cash flow and a low net profit.
What is tax?
Taxes are mandatory levies imposed on individuals and corporations by the government. Taxes collected by the government are used to fund public projects and services. Tax evasion or avoidance is a punishable offense under the law. The Internal Revenue Service (IRS) is responsible for collecting tax and enforcing tax laws in the United States.
There are different types of tax, such as income tax, corporate tax, payroll tax, sales tax, property tax, and tariff tax.
Income tax is levied against taxpayers' earnings. A percentage of an individual or business's income is to be paid as income tax. Individuals pay personal income tax, while businesses pay corporate income tax.
Typically corporate income taxes are levied on a company's taxable income, which is your gross income, with fewer deductions and exemptions. Gross income is calculated as total revenue from all sources (including income from properties and other investments )minus the cost of goods sold.
Your taxable income will be ;
Gross income - operating expenses, general and administrative expenses, depreciation, amortization, and all other exemptions.
According to the Tax Cuts and Job Acts of 2017, corporate income tax is 21% of your taxable income.
What is cash flow after tax?
Cash Flow after tax is the remaining cash flow after tax, operating expenses and interest has been deducted without considering non-cash expenses like depreciation and amortization. CFAT is calculated by adding all non-cash expenses back to the Net income. When calculating your taxable income, these non-cash expenses might have been deducted from your gross income. They are added back after tax payments to show the business's real performance.
CFAT is an important metric used to measure business performance and financial health. It is used to measure a business's ability to generate positive cash flow from its operations after considering the effect of its income tax.
What is the importance of cash flow after tax to your business?
The essence of cash flow after tax is determining the impact of taxation on your profit. It is crucial to determine your CFAT because some non-cash expenses act as a tax shield because you may pay lesser tax if these non-cash expenses are added to your tax deductibles, lowering your taxable income. The lower your taxable income, the lower your tax.
After paying your tax, adding these non-cash expenses back to your net income is advisable to get a good view of your business performance in-house since these tax shields are not part of your cash expenses.
What is the importance of Cash flow after tax to investors?
Investors do consider CFAT when making investment decisions. The value of a business's CFAT can be used to determine if it is a good or bad investment.
CFAT shows the business's real performance - its ability to generate positive cash flow from its operations after deducting the effect of tax. It also shows it can fulfill its cash obligations like debt servicing and generate excess cash to support growth activities such as increasing payroll and working capital, acquiring new assets, and distributing good dividends in the long run. A higher CFAT may indicate that a company can meet its future cash obligations. Although, CFAT is not a standalone metric used to determine a business's financial health.
The disadvantage of cash flow after tax
The primary argument against CFAT is that it doesn't consider cash expenditures for acquiring fixed assets which are gradually deducted through depreciation. As such, it is not a suitable metric for capital-intensive industries. Industries such as energy, transportation, automobile, manufacturing, and semiconductors typically have significant capital expenditure because they have to acquire facilities and equipment to support and expand their operations.
Companies cannot deduct capital costs at once in the year the cost was incurred because the assets purchased will continue to provide value over the years. As such, the cost of acquiring these assets will be deducted gradually by depreciating the assets gradually.
In such a case, CFAT, which disregards depreciation and other non-cash expenses, can not be a suitable metric.
How to calculate cash flow after tax
A company generated a gross income of $500,000 from its operations. It is operating expenses were reported as $100,000. Depreciation and amortization were reported as $50,000 and $30,000, respectively. The company paid a 20% company income tax rate.
First step: Calculate its earnings before tax
Earnings before tax= $500,000 - $100,000+ $30,000+ $50,000= $320,000
Second step: Calculate Net income
Net income = $320,000 - ( $320,000 ×20%)
Net income = $320,000- $64,000
Net income = $256,000
After-tax cash flow = Net income +Depreciation + amortization
After-tax cash flow = $256,000 + $50,000 + $30,000
After-tax cash flow = $336,000.
Is after-tax cash flow the same as net income?
After-tax cash tax flow is different from net income. Net income, also called net profit or net earning, is the total money left after subtracting all business expenses, including interest, tax, and non-cash expenses, from total revenue. You can also get your net interest by subtracting your tax, interest, depreciation, amortization, and other expenses from your gross income.
However, After-Tax Cash Flow does not consider non-cash charges like depreciation and amortization. Such costs are added back to net income to get after-tax cash flow.