GSOE9830 Chap.3 Profit, Tax and After-Tax Cash Flow

Profit, Tax and After-Tax Cash Flow

Profit and net cash flow are different because profit allocates capital cost through depreciation while cash flow records the actual outlay. This chapter uses taxable income as an intermediate bridge to tax, then returns to after-tax net cash flow. It also develops tax relief on operating cost and depreciation, explains loss carry-forward, and shows how an independent reconciliation can catch double-counting.

Taxable income, tax payment and after-tax net cash flow are kept as distinct lines so each sign can be audited. Depreciation reduces taxable income but is added back when after-tax profit is reconciled to cash, while capital expenditure remains a cash outflow at its payment date. A negative taxable result creates no automatic refund unless the stated rule permits one.

Under a carry-forward rule, the unused loss becomes a ledger balance that shelters later income once and then declines.

What this chapter covers

• 01

  Profit versus cash

• 02

  Taxable income

• 03

  Tax payment

• 04

  Depreciation relief

• 05

  Operating-cost relief

• 06

  Loss carry-forward

Worked example · free

Reconcile taxable income and after-tax cash flow

Key terms

Taxable income

Revenue less the deductions allowed for the tax calculation.

Tax relief

The reduction in tax caused by an allowable deduction.

After-tax cash flow

Before-tax net cash flow reduced by the tax payment.

Loss carry-forward

A tax loss applied against later positive taxable income.

Profit, Tax and After-Tax Cash Flow FAQ

Exam move

Build tax questions as two linked schedules rather than one compressed formula. The taxable-income schedule begins with revenue and deductible operating cost, then subtracts depreciation and any other deduction explicitly supplied. The cash-flow schedule begins with actual receipts and payments, includes capital spending when paid, and subtracts the tax payment calculated in the first schedule.

Drawing both prevents depreciation from being treated as a cheque and capital expenditure from being treated as an annual accounting expense. Use a three-line bridge for each operating year: taxable income, tax and after-tax net cash flow. Show the tax rate as a decimal in the multiplication and keep the result as a positive payment amount before subtracting it from cash flow.

If taxable income is negative, pause and read the loss rule. Do not create an immediate refund unless the question supplies one. Under a carry-forward rule, record zero current tax and maintain a separate loss balance. Apply the balance once against later positive taxable income, reduce it by the amount used and carry any remainder forward. Reconcile a positive-income year through a second route.

Calculate profit after tax, add depreciation back because it was non-cash, and account for capital expenditure or working-capital movements separately. The result should match after-tax cash flow from receipts less payments less tax. A difference usually means depreciation was deducted twice, capital spending was omitted, or a tax shield was added without the underlying deductible cost.

Practise tax relief using incremental reasoning. If deductible operating cost rises by $12,000 at a 25% rate, the project loses $12,000 before tax but pays $3,000 less tax, so the after-tax loss is $9,000. Write both effects. For depreciation, there is only the tax reduction because depreciation itself has no direct cash-flow row. Track timing as carefully as amount.

A deduction that occurs earlier can improve NPV even when lifetime taxable income and total undiscounted tax are unchanged. Move one deduction between years in a practice schedule and compare the discounted tax payments. This exercise connects the tax bridge to later depreciation and NPV chapters.

Maintain an error log for profit substituted for cash flow, depreciation entered as cash, capital expenditure deducted twice, negative tax invented without authority, carry-forward reused, and tax rate entered as 30 rather than 0.30. For each error, write the reconciliation that would have exposed it.

Before the test, practise explaining the result in words: identify taxable income, state the payment, state after-tax cash flow and name any remaining loss balance. Never report a tax shield without showing which deduction creates it and when the cash benefit occurs.

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