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Archive for the ‘Cash Flow’ Category

 

 

            Yes nothing. Actually, Zero. When was the last time an investment involving a “zero cash flow” sounded appealing? For most of us, that time would be never. However, there are times when “Zero Cash Flow” property can be of the most instrumental use. The benefits lay in the tax implications for those performing 1031 transactions, if used properly, they can allow someone to leverage a property with (if you can believe it) 90% debt. Of course that debt comes at a cost, namely all those rent checks that would normally be going to you, instead go to your lender (hence zero cash flow). However, after you are done paying off the debt, you would be left with a property completely paid off, most likely highly appreciated in value, and a deferment of the impending capital gains taxes.

 

Here’s how it works:

 

Say someone, Mr. Fornit for example, needs to sell a property worth $7 million, with only $1 million in equity and the rest in debt. The property was originally bought in 2000 for $2 million and if sold today, faces a $5 million capital gains tax liability. To avoid the impending capital gains tax, Mr. Fornit needs to enter into a 1031 but that means the new property must be of equal or more value. After satisfying the $6 million debt obligation, Fornit only has $1 million of cash to reinvest in a property that must be worth at least $7 million to comply with the 1031 rules. To buy a property you need to provide at least 30% of its price in equity. In this situation, Mr. Fornit’s equity would only equal 14% of the total cost.

By entering into a zero cash flow transaction, he can avoid these problems. A zero cash flow transaction is structured almost like a bond, so a bank will invest the $6 million needed into Mr. Fornit’s property and in return will receive the properties rent checks to pay off the debt. In this way the bank recoups its investment and Mr. Fornit ends up with a wholly owned property that satisfies his 1031 and defers his pesky IOU to Uncle Sam.

 

Note:  This kind of transaction only works with investment grade properties to ensure payment stability.

 

            So you may ask: what do zero cash flows from properties have in common with anti-hawkish music by Edwin Starr? One common theme: the best interests of the common man may not be directly aligned with the interests of Uncle Sam. So avoid your unnecessary taxes and stick it to the man!

The cash flow from operating activities shows it is sufficient to repay the debt, pay dividends and invest or not without the external funds. It represents the net increase of decrease in cash from the operations. The rules of how to prepare it is very important, read the below, it can give you some help:

There are two methods to prepare: the direct and indiret method. The direct method shows operating cash receipts and payments, including: cash receipts from customers, cash payments to suppliers and cash payments and on behalf of employees. The indirect method starts with profit before tax and adjusts it for non-cash charges and credits to reconcile it to the net cash flow from operating activities.

In direct method, you should know the sales from customers, the purchases to suppliers, the wages paid to the employees. Here, you must master how to add or minus the corresponding figure.

In indirect method, operating activities only records the inflows and outflows according to the trading. But profit before tax is using the accruals concept. You should adjust the profit before tax into the operating according the trading. So you must understand the depreciation, profit/loss on disposal of non-current asset, balance sheet change in receivables, balance sheet change in inventories, and balance sheet change in payables. And you can’t forget the interest paid and dividends paid. It’s complex in this part, you need understand the meaning of the adjusting details.

This is the beginning of preparing the cash flow statement, you should know the investing and financing.

The Cash Flow Statement is made up of three sections. The first section is operating activities. Operating activities include your company’s profit or loss and non-cash items that affect your profit without affecting cash. Examples of these types of non-cash expenses are depreciation and bad-debt expense. Also included in this section are changes to your operating assets and liabilities. Operating assets and liabilities include accounts receivable, prepaid expenses, accounts payable and accrued liabilities. A common feature of operating assets and liabilities is these items have been reflected in the Profit & Loss Statement in a period different from the period in which they were paid.

The second section of the Cash Flow Statement is investing activities. Investing activities are items such as property and equipment or loans receivables. An interesting aspect of investing activities assets is that they, unlike operating assets, generally do not affect the company’s profit. In other words, investing assets do not represent revenue or expense items.

The third and final section of the Cash Flow Statement is financing activities. Financing activities are debt and equity items. If you increase or decrease your debt, that change is included in financing activities. Equity changes such a capital contributions or shareholder distributions also are reflected under financing activities. Like investing activities assets, financing activities liabilities and equity do not represent revenue or expense items.

The sum of the three sections: Operating activities, investing activities and financing activities is your cash flow for the period being reported. A positive number indicates an increase in cash and decrease indicates a decrease in cash. Now it’s time to take a closer look at the Cash Flow Statement and see why your cash flow is different from your profit.

Compare your cash flow to your profit. If your cash flow is higher than your profit, you are either liquidating assets or increasing your debt, which is negative for your business. On the other hand, it could be that you are increasing your capital, which is a positive for your business.

If your cash flow is less than your profit, you are increasing your assets, such as purchasing property and equipment for future growth or paying down your debt. These are both positives for your business. But it could mean that your money is being tied up in accounts receivable because collections have deteriorated and your business is weakening. Or it could be that you are decreasing your capital, which is a negative for your business.

Cash flow is an indicator of where you are spending your money and the future strength of your business. Small business owners generally do not realize the importance of comparing their past years Cash Flow Statements to measure their business growth. Some of them are ignorant of the basic rules that one should follow to compare their past Cash Flow Statement with the current one. So now that you are aware of these formulas take a few minutes and review your Cash Flow Statement. Compare it with last year and see how your business is progressing. You will be surprised at how much valuable information is contained in your Cash Flow Statement.