How does a tax benefit from issuing options "increase operating cash flow but not income"

CFA Level II
#1

From 3.3 in Reading 34. Could someone explain that or give an example?

#2

i’ve not read it, but…

when you issue options you must account for them using somsthing like BS model. this will be in SG&A, so tax deductable.

NI lower by cost of options.

CFO higher by tax shelter?

#3

wouldn’t a tax shelter increase NI?

maybe NI lower by cost of options, but then cash flow goes up because upon exercise the company receives cash? But would that be CFO?

#4

I am not sure but I think is the way it’s explained above:

Issue options, recognize the expense: Net Income lower

All else equal, tax benefit from the additional expense: CFO higher

#5

oh so because net income is lower via the option expense, CFO is higher compared to not issuing options.

#6

The tax savings are not recognised until exercise, hence the tax benefit is recorded as deferred tax asset on the balance sheet. When you exercise, the DTA associated with previously recognized tax expense is eliminated.This reduction in DTA increases CFO and not net income.

#7

Stock based compensation is none cash. It’s added back to net income like depreciation. like with high depreciation, stock based comp offers a tax shield. You’ll have higher cash flows due to tas shield.

Ni will be lower