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Understanding Cash Flow Before and After Tax

James R Kobzeff

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 any rental property analysis and should be understood by real
estate investors. So, let's look at the formulas.

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 we understand the meaning of the 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

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 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 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

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whenever you make changes to the financial data. Reports such as the APOD, proforma income
statement, and rent scenarios reports all include both cash flows.

About The Author

James R. Kobzeff is a real estate professional and the developer of ProAPOD® Real Estate
Investment Software. Want to analyze the before and after tax cash flow of investment real estate?
See how you can do it in minutes at => www.proapod.com

©2 0 08 J ames R Ko bz eff . All r ig ht s r eser v ed.