Cash Flow Before and After Taxes

Cash flow is all of a rental property's cash inflows less all of its cash outflows.

Think of it as all the money flowing in such as rent, loan proceeds, and interest on bank accounts less all the money flowing out like operating expenses, debt payment, and capital additions and you'll get the idea.

There are two types of cash flow connected with real estate investment property:

1. Cash flow before taxes (CFBT) which doesn't take into consideration the owner's tax liability
2. Cash flow after taxes (CFAT) which does account for tax liability (essentially the cash flow before tax less tax liability).

Both cash flows are important to rental property analysis and should be understood by real estate investors.

Cash Flow Calculation

Net Operating Income
less Debt Service
less Capital Additions
plus Loan Proceeds
plus Interest Earned
= Cash Flow Before Taxes (CFBT)

and,

Cash Flow Before Taxes (CFBT)
less Income Tax Liability
= Cash Flow After Taxes (CFAT)

Okay, now let's look at the calculation to be sure that we understand its various components.

1. Net operating income (NOI) is gross scheduled income less vacancy allowance less operating expenses.
2. Debt service is the total loan payment (first, second, third loans) including principal and interest.
3. Capital additions (different from maintenance and repairs) are improvements to the property having a useful life of more than one year and likely to increase (not merely maintain) the life of the property.
4. Loan proceeds refer to the proceeds obtained from subsequent financing not to the original mortgage, where you might obtain a $40,000 second mortgage to cover the cost of constructing a $40,000 garage for instance.

Cash Flow Example

Say you have a property with ten tenants each paying $1,000 per month ($120,000 per year). You estimate a vacancy and credit loss of 5%. The property has operating expenses of $45,600 per year, and a first mortgage payment of $36,326 per year. In month six, you add a new roof at the cost of $20,000 and take out a $20,000 second mortgage to cover the cost of that construction. Your payment on this loan totals $881 for the remaining six months. What is your property's cash flow before tax (CFBT)?

Gross Scheduled Income 120,000
less Vacancy 6,000
= Gross Operating Income 114,000
less Operating Expenses 45,600
= Net Operating Income 68,400
less Debt Service 37,206
less Capital Additions 20,000
plus Loan Proceeds 20,000
= Cash Flow Before Tax 31,194

If your tax liability in year one is $7,000, than what is your property's cash flow after taxes (CFAT)?

Cash Flow Before Tax 31,194
less Taxes Due 7,000
= Cash Flow After Tax 24,194

Cash Flow Forecasting

Bear in mind that the key to forecasting cash flow from a rental property you're planning to purchase is to be realistic during your evaluation. So it's better to anticipate a small or negative cash flow you can plan to handle with personal funds rather than to encounter a surprise after you purchase the property. Always avoid pie-in-the-sky rents and include all expenses. Remember, you'll be paying for the cash flow a property generates, so be sure you know what the cash flow is most likely to be.

ProAPOD® Real Estate Investment Software computes cash flow before tax (CFBT) and cash flow after tax (CFAT) automatically as you enter the property data. Each is recalculated in real time whenever you make changes to the financial data. Reports such as the APOD, proforma income statement, and rent scenarios include before and after tax cash flows (i.e., CFBT and CFAT).

About the Author
James Kobzeff is the developer of ProAPOD® - leading real estate investment software for agents and investors. It's fast, easy, and concise. Create rental property cash flow and rate of return presentations in minutes! Learn more at => http://www.proapod.com