Calculating Taxes from Cash Flow
Being able to assess a company’s operating cash flow (OCF)–and how that is impacted by taxes–is an important skill in evaluating a company’s overall health.
The operating cash flow indicates the cash a company brings in from ongoing, regular business activities. The operating cash flow can be found on a company’s cash flow statement in the financial reporting done annually and quarterly. Simply, it is Total Revenue – Operating Expenses = Operating Cash Flow.
A company’s EBIT–also known as its earnings before interest and taxes–consists of its net income before income tax and interest expenses are deducted. Once a company’s EBIT is known, multiply that by the tax rate to calculate the total tax paid. Finally, to calculate operating cash flow, use the following equation: EBIT – tax paid + depreciation.
In terms of how to calculate OCF with tax rate already known, the equation above can be simply reverse-engineered, solving for the unknown variables.
Impact of Taxes on Cash Flows
The operating cash flow is important when considering whether the company can generate enough positive funds to maintain and grow its operations. If not, the company may require external financing. Shorter turnover rates in inventory and shorter times for receiving funds increase the operational cash flow. Items such as depreciation and taxes are included to adjust the net income, rendering a more accurate financial picture. Higher taxes and lower depreciation methods adversely impact the operational cash flow.
Implications of Operating Cash Flow
Investors find it important to look at the cash flow after taxes, which indicates a corporation’s ability to pay dividends. The higher the cash flow, the better the company is financially, and the better positioned it is to make distributions. Income the company has from outside of its operations is not included in the operating cash flow. Any dividends paid and infrequent long-term expenses are often excluded from this calculation as well.