Should tax expenses be taken into account when calculating cash from operations? I have found several conflicting examples and I am a little confused. Thanks
the difference between tax expense on the income statement and actual cash paid to uncle sam will be a deferred tax asset (liability) which is deduction (addition) to CFO
whodey Wrote: ------------------------------------------------------- > the difference between tax expense on the income > statement and actual cash paid to uncle sam will > be a deferred tax asset (liability) which is > deduction (addition) to CFO To be more accurate, the CHANGE in that deferred tax account is the adjustment to CFO
That cash taxes paid definitely reduce the cash from operations. How you account for taxes in the CFO completely depends on how you build the statement, however. If doing an indirect method from Net Income, you need to adjust for the non-cash taxes. However, if you build CFO from EBITDA (which is what I do for work), you simply deduct cash taxes.
Okay, let’s be clear. There is the indirect and direct way to calculate CFO. I’m not going to explain them here in detail, but here is how they basically work. Direct: Ad up inflows, sutract outflows. Cash paid for tax expense is an outflow. This method is the least common, least used, but it is tested. Indirect: Start with net income (asif presuming that all components are cash), and back out those items that are not cash related. This is where you would adjust NI for the change as I mentioned above. (and I should have specified that I was referring to indirect) mcf’s comments re using EBITDA are not relevent for exam purposes
more specifically, there is a question in the CFA book which states that a company has changed the depreciable lives of some of their fixed assets and the change will result in a $58 million decrease in depreciation expense. The question asks what the change will be on cash from operations. The answer in the book states that there would be no change b/c depreciation is not a cash flow. However, wouldn’t the decrease in depreciation increase your cash taxes and thus reduce your cash from ops?
When your depreciation expense reduces – you have a DTA (Deferred tax asset) that kicks in, which would reduce the actual tax expense to what it was in the previous year. If you took an example: 100 = Sales, COGs = 50, Int = 10, Depreciation = 20 and tax @ 40% EBIT = 100 - 50 - 20 = 30 EBT = 30 - 10 = 20 Tax = 8 NI = 12 CFO = 12 + 20 (Dep) = 32 Now say dep reduces to 12 EBIT = 100 - 50 - 12 = 38 EBT = 38 - 10 = 28 Tax = 28 * .4 = 11.2 DTA = (20 - 12) * .4 = (3.2) —> reduction due to creation of a DTA Actual Tax Expense = 11.2 - 3.2 = 8 NI = 28 - 8 = 20 CFO = 20 + 12 = 32 So no change in the Cash Flow from Operations. Hope this helps. CP
thanks CP - that definately helps
and why do you get a deferred tax asset? I thought those resulted from a difference in the accounting for financial statements and for tax purposes. In CP’s example are we somehow paying more tax than our accounting would show?
read SuperI’s post above… this actually would be an adjustment to COGS – so COGS would have increased — and not the way I have shown above. but the net result would be an increase in NI – which would adjust for the CFO automatically. CP
? an increase in COGS because of a reduction in depreciation expense?
The change in depreciation expense won’t change COGS, but it will impact the NI because the depreciation expense will be reducted from the gross profit. Regarding the CFO, the income tax paid to government will be calculated by another depreciation system, so no matter how you adjust your depreciation method, it will only affect the financial statement, the tax paid to government will be the same. That’s why it will affect the deferred tax asset/liablity.