The amount of money an investment produces after the collection of all revenue items and payment of operating expenses and debt service. This cash flow comes before the calculation of one’s income tax liability, and does not factor in deductions for depreciation allowance, mortgage interest expense or other non-cash items.
Pre-tax cash flow allows investors to calculate their current return on investment, and when comparing to after-tax cash flow, provides context to the extent of tax shelter a particular investment may generate.
Pre-tax cash flow is also referred to as "before-tax cash flow" (BTCF) or "equity dividend." We can calculate pre-tax cash flow using a simple formula:
Pre-Tax Cash Flow = Net Operating Income – Debt Service
Taxes can vary greatly from investor to investor. Comparing two different investments using after-tax numbers leaves out too many variables that can hide in the tax calculations. By removing tax calculations, pre-tax cash flow strips away investor tax-related differences.
As many real estate investors know, a property can show a paper loss but generate positive cash flow. You can see this in the pre-tax cash flow value. It may be positive, but once deductions are applied, the after-tax value may be negative. However, the property still generated positive cash flow.
Pre-tax cash flow is also used to calculate the cash on cash value:
Cash On Cash = (Pre-Tax Cash Flow) / (Total Cash Invested)
Cash on cash shows the investor’s return on actual money put into the property. Unlike pre-tax cash flow, cash on cash is a ratio rather than a dollar amount.
