June 18, 2024

Sustainable Cash Flow: A Critical Component of Alimony and Child Support Calculations

By Ilan Hirschfeld, CPA/ABV/CFF, MBA, Partner-in-Charge, New Jersey Advisory Services & Minh Doan, Staff Accountant, Advisory Services

Sustainable Cash Flow: A Critical Component of Alimony and Child Support Calculations Marital Dissolution

When we hear the term “cash flow,” we generally think of cash flow as presented in publicly traded companies’ Statements of Cash Flow. Often, cash flow is confused with the income reflected on the parties’ tax returns. However, in matrimonial accounting, “Cash Flow” refers to the actual cash flow that has historically been realized and thereby provided the wherewithal to fund the disbursements in support of the lifestyle that the parties have generally become accustomed to during the more recent years of the marriage. This would include the cost of housing, transportation, and personal needs including savings.

The individual tax returns (Form 1040) are the usual starting point in determining cash flow. However, these tax returns provide the parties’ reported taxable income as opposed to their actual economic income. Adjustments must then be made to the reported taxable income to convert it to the actual cash flow during the years being analyzed. Depending on the complexity of the parties’ financial circumstances, there can be many varied income components that must be addressed. These could include, but are not limited to, capital gains/losses, stock options, severance payments, sign-on bonuses, forgivable loans, accumulation of non-operating cash within the business, and other non-recurring items.

Similarly, perquisites and benefits must be determined and addressed to convert reported taxable income to the future sustainable cash flow. Appropriate adjustments to arrive at sustainable cash flow can often be subjective and require professional judgment.

Items that are unusual in nature, and/or infrequent in occurrence require adjustments. While they may have impacted cash flow in the past, one must consider whether they are likely to recur and whether they should be considered as a component of future sustainable cash flow. It is important to remember that these adjustments could result in a significant difference between the historical cash flow and the future sustainable cash flow.

Examples of non-recurring items include, but are not limited to, the following:

I) Severance Packages

  • While appropriately included in income and historical cash flow, severance package benefits should be excluded from sustainable cash flow due to their non-recurring nature.

II) COVID-19 Impact and other “Hundred-Year Storm” types of occurrences

  • The related impact on future sustainable cash flow must be considered when the business was negatively or positively impacted due to COVID-19, a fire, flood, etc.

III) Stock Options and other equity-type awards

  • The various equity equivalents received (stock options, RSUs, grants, etc.) are components of income. However, the subsequent increases or decreases in the price of the underlying stock after the grant date may have had a dramatic impact on historical cash flow, which would not necessarily be a representative recurring component of future or sustainable cash flow, just as would be the case with any capital gains or losses.

IV) Other factors that should be considered

  • Gains or losses from the sale of a business
  • There are many items impacting the business operations and future distributions:
    • Discontinuation or addition of product lines
    • New channels of distribution
    • Closure of an operating facility
    • Major capital expenditures
    • Early starting losses relating to a new business
    • Lawsuits – positive or negative results

Considerations must also be given to the fact that once marital assets are divided, an individual’s ability to pay support will be impacted, and, therefore, the level of prior passive income may not necessarily reflect future sustainable cash flow.

Cash flow is a critical factor in determining the payor’s ability to pay alimony and child support. It provides us with the information needed to understand the resources available to support the marital lifestyle during the relevant years. While the importance of this information can not be overemphasized, solely relying on historical cash flow without focusing on sustainable cash flow can lead to conclusions and positions that may be unfair to one, if not both, litigants.