Cash Flow – Knowing What the Property Provides
Cash flow is all of a rental property’s cash inflows less all of its cash outflows. Just think of it as all the money flowing in such as rent, loan proceeds, and interest on bank accounts less all the money flowing out like operating expenses, debt payment, and capital additions and you’ll get the idea.
There are two types of cash flow connected with real estate investment property: Cash flow before taxes (CFBT)—does not consider the owner’s tax liability—and cash flow after taxes (CFAT)—does account for tax liability.
How to Calculate Cash Flow
Net Operating Income
less Debt Service
less Capital Additions
plus Loan Proceeds
plus Interest Earned
= Cash Flow Before Taxes (CFBT)
and,
Cash Flow Before Taxes (CFBT)
less Income Tax Liability
= Cash Flow After Taxes (CFAT)
Just to be sure you understand the formula let’s cover its components. Net operating income (NOI) is gross scheduled income less vacancy allowance less operating expenses. Debt service is the total loan payment (first, second, third loans) including principal and interest. Capital additions (different from maintenance and repairs) are improvements to the property having a useful life of more than one year and likely to increase (not merely maintain) the life of the property. Loan proceeds refer to the proceeds obtained from subsequent financing not to the original mortgage, where you might obtain a $40,000 second mortgage to cover the cost of constructing a $40,000 garage for instance.
The key to forecasting the cash flow a rental property you’re planning to purchase generates is to be realistic during your evaluation. It’s always better to anticipate a small or negative cash flow you can handle with personal funds rather than to encounter a surprise after you purchase the property. Avoid pie-in-the-sky rents and include all operating expenses when you conduct your rental property analysis. Remember, you’ll be paying for the cash flow a property generates, so be sure you know what the cash flow is most likely to be.
ProAPOD® Real Estate Investment Software computes cash flow before tax (CFBT) and cash flow after tax (CFAT) automatically as you enter the property data. Each is recalculated in real time whenever you make changes to the financial data. Reports such as the APOD, proforma income statement, and rent scenarios include cash flows you can preview on our website.
