Calculating taxes in operating cash flow is a great way to get a more accurate picture of how much money is coming in and going out of your company—an integral part of overall business tax. It’s also important for understanding the health of your business because it gives you an idea of how much cash is available for paying bills and other expenses.
The following are some things you should know before you start:
Understanding Cash Flow, Limitations, & Calculations
Cash flow is one of the most important metrics for investors, lenders, and entrepreneurs alike. It measures a company’s ability to generate cash from its operations.
On the surface, cash flow seems simple. You take the net income from a company’s income statement and subtract any non-cash expenses like depreciation or inventory write-downs. The resulting number is the company’s operating cash flow (OCF).
But there are some nuances that can cause problems if they are not understood.
We will explain exactly what you need to know about operating cash flows and how they are calculated—including limitations, what it means for investors, and why it’s useful for companies to track them.
Terms to Know
This is the amount of money that comes in from your business. It includes all revenue streams, including sales of goods or services, interest income, and any other income you receive.
Operating expenses include all the costs incurred by a company in order to operate its business. Examples of operating expenses include salaries and wages, rent, utilities, insurance, advertising and marketing costs, travel expenses, and repairs and maintenance costs.
Operating expenses are considered by accountants to be variable costs because they fluctuate according to the level of activity for a given period of time.
Operating income is the income your company receives from its business activities that are not related to long-term investments or capital gains. Operating income includes all revenues from selling goods or services to customers, as well as any other income earned by your company.
Depreciation is an accounting concept used to account for the wear and tear on assets that are used up over time. You calculate depreciation by dividing the cost of an asset by its useful lifespan (usually a period of five years or less).
For example, if you paid $10,000 for a piece of equipment with a five-year lifespan then you would depreciate $2,000 each year ($10,000/5 years). The resulting net book value at the end of five years would be $6,000 ($10,000 – $2,000 – $1,600 – $1,200 – $1,000).
This method allows businesses to spread out their taxes over time instead of paying them all at once when they buy new equipment.
Net income is the amount of revenue that a company earns, minus all expenses. In other words, net income is the total amount of money a company brings in after paying for all its expenses.
For example, if your gross sales are $1 million, but you spend $750,000 on overhead costs and only take home $250,000 in profit, then your net income would be $250,000.
Working capital is the difference between current assets and current liabilities. It’s a measure of how much money a company has access to for day-to-day operations.
If a company has a positive working capital, it can afford to pay its debts without having to take out loans, which means it is more stable than one with negative working capital, which might have trouble paying its debts. This figure is also used as an indicator of future profits since it indicates how much cash flow the company has available for reinvestment and expansion purposes.
Assets include cash, accounts receivable, inventory, fixed assets, and intangibles, but not current assets (inventory). If a company has a large amount of inventory on hand, it would be included as an asset on its balance sheet.
However, if the company is using this inventory to produce products or services that it will eventually sell and collect from customers in exchange for cash, then it is important to include this inventory as current assets because it is not being held for long-term purposes.
Liabilities include things like accounts payable (money owed to suppliers), accrued expenses (unpaid bills), long-term debt (debts that have been borrowed for longer than one year), and more.
Essentially, liabilities are future payments that you may be required to make. For example, if you have a loan with a bank, that loan will have monthly payments that are due over time. These monthly payments are considered liabilities because they are future payments that you have to pay back at some point in time.
How Do You Use Operating Cash Flow Statement Information?
When you have a firm grasp of your company’s cash flow, you can see exactly where your business stands and what steps you need to take next. You won’t be guessing about whether or not your business is making money, or if it is, how much. You will know exactly where things stand and how close your business is getting to its goals.
Using operating cash flow statement information, for example, you can track how much money your business is bringing in from sales and how much goes out to cover costs. You can also see how much cash is available to pay off debt or make investments in inventory or equipment.
You might use these reports to help determine whether it is time to make some changes in your business plan, such as lowering prices or increasing advertising spending.
The more detailed your records are, the easier it will be to analyze them later on if needed. Learn how to calculate taxes in operating cash flow below.
Calculating Taxes in Operating Cash Flow
Calculating taxes in operating cash flow is not as difficult as it may seem, but it can be confusing to someone who has never done it before.
First, you need to know what your total income is. This is your total revenue minus any expenses that were paid during the year.
Then, you need to calculate your tax rate, which is how much of your total income you owe in taxes. Next, subtract this amount from your total income to get your net income.
Finally, divide this number by 12 and add it back into your operating cash flow calculation. This will give you an accurate account of how much money you have left over after paying all of your taxes for the current year.
Operating Cash Flow Formula
Operating cash flow is a measure of the amount of cash generated by a company’s operations. It is calculated by subtracting capital expenditures (the money spent on assets like new equipment) from net income. This means that operating cash flow does not include investment or financing activities, which can include things like paying down debt or issuing stock.
Operating Cash Flow = Net Income – Capital Expenditures
Here is an example: Imagine Company XYZ has $1,000 in revenue and $200 in costs but spends $300 on new equipment for its factory. Its net income for the year would be $700, but if you subtract the $300 spent on capital expenditures from that number, you get an operating cash flow of $400.
Limitations of Cash Flow
Cash flow is one of the most important metrics for a business. It provides a clear picture of how well a company is doing, and it helps you determine whether or not you should continue investing in your business.
However, cash flow calculations are limited in what they can tell you about your company’s performance. They don’t take into account other factors that have an impact on the health of your business, such as depreciation, amortization, and changes in working capital.
For example, if you own a small business that makes widgets and sells them to customers, you will notice that some months are busier than others because of seasonal demand. You may find that during busy months like December or July, sales are higher than usual, but expenses increase as well due to increased labor costs associated with shipping more widgets out the door.
This means that while your company’s total revenue may be higher than usual during these months, it doesn’t mean that its profitability has necessarily improved because there were also increases in expenses related to production costs associated with shipping out more widgets per hour when demand was higher than normal (comparison).
Frequently Asked Questions
We have compiled a list of some of the most common questions about operating cash flow and how to calculate it.
Is Income Tax an Operating Cash Flow?
No, income tax is not an operating cash flow. The reason is that income tax is not a cash expense. It is a non-cash charge and therefore it should not be included in your operating cash flow calculation.
Income tax is classified as a non-cash expense because it does not involve any actual payment or receipt of cash. Instead, income taxes are either the increase or decrease in deferred taxes payable or receivable on account of timing differences between when revenues are recognized and when expenses are paid for tax purposes.
In other words, if you receive a $1 million salary, but only pay income tax on $800k of it due to deductions like 401(k) contributions and HSA contributions, then you have received $1 million but only paid out $800k in cash.
Is Paying Taxes an Operating Activity?
Yes. Paying taxes is part of the operating activities of your business. You can include it in your operating cash flow when calculating taxes in operating cash flow.
In general, you do not have to include taxes paid as an expense on your income statement. Instead, you can include these expenses as part of your operating activities when calculating taxes in operating cash flow.
However, if the tax is a nonrecurring one-time expense, then you could choose to include this amount as an expense instead of including it in your operating cash flow when calculating taxes in operating cash flow.
Where Do You Find the Net After-Tax Profit in the Cash Flow Statement?
The net after-tax profit is found in the “operating activities” section of your cash flow statement. It is one of three types of income, representing all of your revenues less all your expenses for a particular time period.
What Are Deferred Taxes on Cash Flow Statements?
Deferred taxes are taxes that are not paid until a future date. They can either be deferred as a result of losses or because the company expects to pay taxes in the future.
For example, if a company loses money for several years in a row, it may have deferred tax liabilities that are due at some point in the future.
What’s Included in Operating Cash Flow?
Operating cash flow is a measure of the cash a company generates from its normal business activities. It subtracts capital spending and other non-cash expenses, like depreciation and amortization, to give you an idea of how much money the company has left over after paying all its bills.
Included in operating cash flow are:
- Revenues earned through sales of goods and services
- Interest income from investments made by the firm
- Rental income from property owned by the firm
The operating cash flow number is also known as “free cash flow” because it shows you what is left over for your company to spend on whatever it wants—whether that is paying down debt or buying back stock or investing in new projects and acquisitions.
The Bottom Line
In the end, the logic behind calculating taxes in operating cash flow is simple: you want to know how much cash you can expect from your business after you take out taxes. That way your business meets its tax obligations, and you have a clear picture of how much cash is available for reinvestment in other parts of your business (like expansion). With this information at your fingertips, it is easier to make smart business decisions for the future of your company.
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