Net Income After Tax vs. Levered Cashflow

In real estate modelling, why do we subtract principal repayments from Net Income After Tax to get the cash available to equity holders if we’ve already deducted debt in calculating net income? Wouldn’t that mean we’re subtracting the debt principal twice?

Net Income After Tax

Net Income After Tax (NIAT) is an accounting measure that includes:

  1. Gross revenue
  2. Minus operating expenses
  3. Minus interest expenses
  4. Minus depreciation and amortization
  5. Minus taxes

At this stage, interest expense (the cost of debt) has been deducted, but not the principal repayments on the debt.

Levered Cash Flow

Levered Cash Flow, also known as Cash Flow Available to Equity (CFAE), represents the actual cash available to equity holders after all cash inflows and outflows, including debt service. To calculate this:

  1. Start with Net Income After Tax
  2. Add back non-cash expenses (like depreciation and amortization)
  3. Subtract changes in working capital
  4. Subtract capital expenditures
  5. Subtract principal repayments on debt

Why Principal Repayments Are Subtracted

The principal repayments are subtracted at this stage because:

  1. Accounting vs. Cash Flow: NIAT is an accounting measure, while Levered Cash Flow is a cash flow measure. Principal repayments are not an expense on the income statement (and thus not in NIAT), but they are a cash outflow.
  2. Interest vs. Principal: While interest payments are included in NIAT as an expense, principal repayments are not. They represent a reduction in the liability on the balance sheet, not an expense.
  3. True Cash Available: By subtracting principal repayments, you arrive at the true cash available to equity holders after all obligations have been met.

Not Double Counting

This process does not result in double-counting the debt:

  • Interest expense is accounted for in NIAT
  • Principal repayments are accounted for in the conversion from NIAT to Levered Cash Flow

In essence, you’re not deducting debt principal twice. You’re accounting for the full cost of debt by including both the interest (in NIAT) and the principal repayments (in the conversion to Levered Cash Flow).

Conclusion

In real estate modeling, subtracting principal repayments from Net Income After Tax to arrive at Levered Cash Flow is a necessary step to accurately represent the cash available to equity holders. This process ensures that all cash inflows and outflows, including the full cost of debt service, are accounted for in the final cash flow figure.