Cash flow after taxes (CFAT) is a measure of financial performance that looks at the company's ability to generate cash flow through its operations. It is calculated by adding back non-cash charges such as amortization, depreciation, restructuring costs, and impairment to net income.
CFAT = Net Income + Depreciation + Amortization + Other Non-Cash Charges
CFAT is also known as After-Tax Cash Flow.
Understanding Cash Flow After Taxes (CFAT)
Cash flow after taxes is an important measure of cash flow that takes into account the impact of taxes on profits. This measure is used to determine the cash flow of an investment or project undertaken by a corporation. To calculate the after-tax cash flow, depreciation must be added back to net income, since depreciation is a non-cash expense that represents the declining economic value of an asset, but is not an actual cash outflow. (Remember that depreciation is subtracted as an expense to calculate profits. In calculating CFAT, it is added back in.)
For example, let’s assume a project with an operating income of $2 million has a depreciation value of $180,000. The company pays a tax rate of 35%. The net income generated by the project can be calculated as:
Earnings Before Tax (EBT) = $2 million - $180,000
EBT = $1,820,000
Net Income = $1,820,000 - (35% x $1,820,000)
Net Income = $1,820,000 - $637,000
Net Income = $1,183,000
CFAT = $1,183,000 + $180,000
CFAT = $1,363,000
Depreciation is an expense that acts as a tax shield. However, as it is not an actual cash flow, it must be added back to the after-tax income.
The present value of cash flow after taxes can be calculated to decide whether or not an investment in a business is worthwhile. CFAT is important for investors and analysts because it gauges a corporation's ability to pay cash dividends or distributions. The higher the CFAT, the better-positioned a business is to make distributions. However, a positive CFAT does not necessarily mean that a company is in a healthy financial position to make good on its cash distributions.
CFAT also measures a company's financial health and performance over time and in comparison to competitors within the same industry, since different industries have different levels of capital intensity and, thus, different levels of depreciation. While cash flow after taxes is an excellent way to determine whether a business is generating positive cash flows after the effects of income taxes have been included, it does not account for cash expenditures to acquire fixed assets.