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The cash flow statement is by far the most important financial
statement generated by the On Target software. It establishes
the viability of your investment. A negative after-tax cash
flow in the first year of operation indicates that you will be
feeding the property to keep it going. Positive after-tax cash
flows indicate a profit. ( Money in Your Pocket ) It is
important to get the input data set up correctly for your first year
of operation. If the rents are at market value when you
purchase an income property and you won't be increasing the rents
during your first year of operation, set the first year income
growth rate to 0 (Zero) via the Set Year-to-Year Growth Rates
Screen.
In summary, you should have a good understanding of each line
item on the Cash Flow Statement. The net operating
income is used in 2 very important real estate ratios, the cap rate
and the debt coverage ratio. The cap rate can be compared to a
market cap rate for the type of property you are analyzing to
determine if the property is over priced. The debt coverage
ratio measures risk. Lenders use the debt coverage ratio to
determine if the income for a property is sufficient to cover
operating expenses and debt service. The Before-tax cash flow
and after-tax cash flow amounts are used in the Cash on Cash return
calculation. Cash on cash return measures the return on your
initial investment amount. The Cash Flow Statement should play
an important role in your buy and sell decisions.
Federal Tax Liability / State Tax
Liability - These are the amounts of
federal taxes and state taxes that you will owe on the taxable
income that was computed on the income statement. State taxes
are deductible on your federal return and are subtracted from the
taxable income amount before computing your federal tax liability.
Capital Additions - are permanent
structural improvements which add value to a property such as a
new roof, an addition, new siding, etc. The cost of a capital
addition is subtracted from the after-tax cash flows in the year
that it is put into service. You can offset the cost of a
future improvement by putting a loan on the property using Loan 3
entry fields. Residential improvements are depreciated over
27.5 years and commercial improvements are depreciated over 39
years.
Balloon Payment
- Interest only loans with a term of less than 10 years result
in a balloon payment. You can balloon both an interest
only loan and a fully amortized loan. A balloon payment can be
offset by adding a future loan via loan 3. If an offsetting
future loan is not put on the property, the balloon payment
amount will be subtracted from the after-tax cash flows for the
balloon year and will reduce the cumulative after-tax future wealth.
Refinancing - You can put a future loan on the
property to offset an improvement or
balloon payment via Loan
3. A future loan can also be used
to take cash out of a property.
Net Present Value
- also known as discounted cash flows is a
valuation method which discounts cash flows in the future back
to the present to estimate the attractiveness of an investment.
The calculation uses the initial investment amount, the series of
after-tax cash flows and the after-tax sales proceeds in a given
year and discounts these values back to the present with a discount
rate that reflects the investment risk and anticipated return.
A negative net present value suggests that the investment doesn't
meet investor expectations. A positive net present value
indicates that the investment meets expectations. The larger
the net present value, the better the investment.
(c) Copyright 2000 - 2008
Advantage Software LLC
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