What it means
Profit and cash are different things. Accounting profit includes non-cash charges such as depreciation (the gradual write-off of an asset's cost), while cash flow shows money that actually moved in and out of the bank.
CFAT starts with the cash an investment earns before tax and then subtracts the tax that has to be paid on it. A key feature is the depreciation tax shield.
Depreciation is not a cash payment, but it reduces taxable profit and therefore reduces the tax bill. This is why CFAT is often higher than net income, and why investment decisions about equipment and property are sensitive to how depreciation is treated for tax.
CFAT is a core input in capital budgeting, the process of deciding which projects to fund. Analysts forecast CFAT for each year of an investment, then discount those cash flows back to today to find the net present value.
Using after-tax figures avoids overstating the return, which can happen if tax is ignored. It is also widely used in real estate.
An investor buying a rental property looks at the rent received, the operating costs, the interest paid and the tax due, and tracks the cash left over each year. That figure is compared with the money invested to judge whether the property is a good use of capital.
The nuance is that the exact calculation depends on tax rules, which vary by country and change over time. Some analysts also include financing cash flows such as loan repayments, while others do not, so always check how a given CFAT figure was defined before comparing it with another.
In practice
Real-world examples.
Example
A bakery chain considers buying a $400,000 oven line. The finance manager forecasts the extra sales and costs, applies the tax rate, and adds back depreciation to get CFAT each year. The after-tax view shows the payback period is nearly a year longer than the pre-tax estimate suggested.
Example
A property investor buys a small apartment block and collects rent of $120,000 a year. After operating costs, interest and tax, the CFAT is $48,000. She compares that to her $600,000 equity investment to see an 8% after-tax cash yield.
Example
A software company weighs two projects with similar pre-tax returns, but one involves heavy equipment spending and the other is mostly staff costs. The equipment project has a higher CFAT because depreciation shields part of the profit from tax. The CFO chooses it, after checking that the tax treatment is reliable.
Formula
Calculation
CFAT = Cash flow before tax - Tax paid
Equivalently, CFAT = Net income + Depreciation (and other non-cash charges)
Suppose a small manufacturing line earns $500,000 of revenue, pays $300,000 of cash operating costs, and has $50,000 of depreciation. Taxable profit = 500,000 - 300,000 - 50,000 = $150,000, and at a 30% tax rate the tax is 150,000 x 0.30 = $45,000. Net income = 150,000 - 45,000 = $105,000, so CFAT = 105,000 + 50,000 = $155,000. Check: cash flow before tax is 500,000 - 300,000 = $200,000, and 200,000 - 45,000 = $155,000, which matches.Case study
Seen in the real world.
Linden Park Logistics is a fictional courier firm that evaluated a new fleet of delivery vans. The first analysis used pre-tax cash flow and made the purchase look very attractive. The finance manager redid the analysis using CFAT, applying the tax rate and the depreciation schedule for the vans.
After tax, the annual cash flow was lower than first thought, but the depreciation shield kept it positive and the investment still cleared the company's required return. The board approved the purchase with a clearer view of what cash to expect.
This is an illustrative story about an invented company. It shows why decisions should rest on after-tax cash flows, because tax can turn a marginal project into a weak one, or make a good one even better.
Watch out
Common mistakes.
- Using net income as if it were cash flow. Net income is reduced by depreciation, which is not a cash outflow, so you need to add it back.
- Forgetting that tax rules change. A forecast that assumes today's depreciation and tax treatment for ten years can be badly wrong.
- Comparing CFAT figures built on different definitions. One may include loan repayments and another may not, so the numbers are not like for like.
Questions
People also ask.
Is CFAT the same as free cash flow?
Not exactly. Free cash flow usually subtracts capital spending and changes in working capital as well, while CFAT focuses on the effect of tax on operating cash flow.
Why add back depreciation?
Because it is an accounting charge, not a cash payment. It reduces tax but the money is still in the bank.
Is a higher CFAT always better?
Not on its own. You also need to compare it with the amount invested and the risk involved.
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