How To Calculate Taxes in Operating Cash Flow

Understanding Cash Flow Uses, Limitations, and Calculations

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Cash flow provides insight about the financial health of an organization. A business’s cash flow can be assessed using different methods, depending on the type of cash flow activity and other factors.

Operating cash flow, represented on the cash flow statement, refers to the income that flows in and out of a business due to its operational income and expenses.

Learn how operating cash flow works, how it is used, and how you can calculate taxes from it.

Key Takeaways

  • Cash flow refers to the way money flows in and out of a business during a specific time.
  • A company’s cash flow can indicate whether it is likely to meet its financial obligations.
  • Cash flow can be categorized into three different types: operating cash flow, investing cash flow, and financing cash flow.
  • The amount of taxes owed by a business can be determined by subtracting EBIT and depreciation from the operating cash flow.

How Do You Use Cash Flow Information?

Cash flow refers to the way in which money flows into and out of a business, and operating cash flow is cash flow that is connected with operating activities.

Operating cash flow is useful for helping executives track their business’s financial health so they can make decisions on how it will operate. Management can determine whether the business can afford its expenses, and whether they need to make changes. Cash flow is also used to prove a business’s creditworthiness to lenders and investors.

Unlike an income statement that shows a company’s profits, a cash flow statement shows a beginning cash balance, ending cash balance, and the difference between the two.

How To Calculate Taxes in Operating Cash Flow

Operating cash flow refers to the money that goes in and out of a business due to income and expenses related to its operations.

Operating expenses are normal expenses required to run the business, such as payroll and costs of materials to manufacture products. A positive operating cash flow helps ensure the business can afford to continue its operational duties and grow. Otherwise, it may need financing.

Operating Cash Flow Formula

The operating cash flow of a business can be calculated using the following formula:

Operating Cash Flow = EBIT + Depreciation – Taxes

EBIT refers to the earnings before interest and taxes. This is the amount the business made from its revenue minus the operating expenses. To determine the operating cash flow, the business must track its depreciation of assets used for operations and add this amount to its EBIT. After this has been calculated, it must deduct the amount of taxes owed to reach the operating cash flow.

For example, if a business earned $500,000 in revenue and incurred operating expenses consisting of salaries, materials, and equipment of $400,000, then the $400,000 is deducted from the $500,000 to find the EBIT, which is $100,000.

If depreciation was $60,000, but taxes owed were $75,000, the operating cash flow calculation would be:

Operating Cash Flow = $100,000 + $60,000 - $75,000

So, the company would have $85,000 of operating cash flow.

Typically, a business calculates its taxes due by multiplying the tax rate by the amount of taxable income made by the business. By analyzing the operating cash flow equation, a business can determine how tax is impacting the amount of cash flowing into the business.

Reversing the operating cash flow equation by subtracting EBIT and depreciation from the operating cash flow amount allows a business to see just how much taxes are impacting this amount.

Limitations of Cash Flow

Cash flow analysis has its limitations when it comes to determining the value and success of a business.

A cash flow statement only looks at the income and expenses that flow in and out of a business. It doesn’t include other assets of the business that can bring value, such as equipment and intellectual property. It doesn’t account for any other factors that could impact its growth, such as intangible assets like reputation and customer base, nor does it reflect whether the money flowing comes from a loan.

Cash flow is not the only indication of its potential growth and development. Metrics on other financial statements such as the income statement and the balance sheet also provide key information.

Keep in mind that cash flow is not the same as profitability, which is another key indicator of a business’s financial strength. They are separate metrics showing different perspectives of the business. A business can have a positive cash flow but not profit, or it can generate a good profit and still have a negative cash flow.

The Bottom Line

Cash flow analysis is used for a variety of reasons because it provides insight to the financial health of the business. Operating cash flow is specific to the activities having to do with the operations of the business. Understanding how to use the operating cash flow equation to determine how taxes are impacting the cash inflow can help business executives make financial decisions.

Frequently Asked Questions (FAQs)

Why would someone prefer to look at before-tax cash flow rather than after-tax cash flow?

Businesses that want to track their progress and their spending habits before tax is considered might want to look at their cash flow before tax. By referencing the before-tax cash flow, the business only focuses on the revenue made after operating costs and capital costs, which can help provide insight to its progress.

Where do you find the net after-tax profit in the cash flow statement?

The net after-tax profit for a specific period can be reflected by the amount at the bottom of the cash flow statement. The bottom line of the cash flow statement is referred to as the cash balance.

What are deferred taxes on cash flow statements?

Deferred income tax on a cash flow statement refers to the amount of tax that has not yet been paid but is expected to be owed. This typically occurs when assets are depreciated using different methods and there is a variance between these two amounts.

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Article Sources

  1. Securities and Exchange Commission. “Beginners' Guide to Financial Statements.”

  2. Harvard Business School. “Cash Flow vs. Profit.”