November 3, 2022

Commonly Overlooked Issues in Cash Flow Analyses

By Christopher Byrnes, Manager, Advisory Services

Commonly Overlooked Issues in Cash Flow Analyses Marital Dissolution

At Marcum we often are engaged, as part of a marital dissolution, to prepare an after-tax cash flow analysis for the purposes of determining the historical income and cash flow of the parties. These cash flow analyses can be essential in assisting counsel in the negotiation and determination of such items as alimony and child support.

First, a couple’s income will be reviewed via their personal income tax returns, whether they file jointly or separately. A number of standard adjustments will be made to arrive at a pre-tax cash flow figure for each year prior to deducting the actual taxes paid. There are, however, a number of potentially overlooked adjustments or aspects of a cash flow analysis which must be taken into account. A few examples of which are conveyed below.

In a historical after-tax cash flow analysis, if a bad year occurs, such as a COVID year with a lower-than-normal bonus, should that be included? If a spouse started a new job in 2020 earning double what they made in 2019, why would we average that with the prior years? It is not the current reality. Some logic and common sense need to be utilized when determining what the projected cash flow will be going forward, not always a simple average of prior years.

Capital gains or losses and other gains or losses are often reversed and deducted from an after-tax cash flow analysis as there is no basis to determine if these will recur in the future. However, often the associated taxes related to these gains or losses are overlooked and must be added back (or deducted) to the analysis, otherwise the analysis will have an over or under payment of taxes in its after-tax figure.

A net operating loss (NOL) is the result when a company’s allowable deductions exceed its taxable income within a tax period. These deductions can be carried forward to offset future income and reduce the amount of taxes, which need to be paid that year. The NOL is reversed as an adjustment if the NOL will not be available to be deducted in future years, in particular the duration of the support payments. Once this adjustment is made the associated taxes need to be included to accurately display what future cash flows is projected to be.

More accurate and logical cash flow analyses will result in not only the chance of a fairer settlement but also reduce the likelihood of a change in circumstance being filed in the future. These are just a few items which a Marcum professional would take into consideration when preparing an after-tax cash flow analysis and it may result in a significant difference to the bottom line.