Should I build an "after tax" or a "before tax" business case?
If your business case refers to a government or non-profit organization, the "Tax" question is a non-issue. For tax-paying companies, however, it is an important question. Results of "before tax" and "after tax" business cases can look quite different. Here are some ways that taxes can impact the cash flow results of a business case:
- Taxes lower overall gains
Where the business case shows gains or net cash inflows, taxes operate to lower overall gains because operating income and capital gains are normally taxed. If the total income tax rate is, say 30%, a $100 operating gain becomes a $70 net gain after taxes.
- Taxes also reduce overall cost and expense impacts
Where the business case shows losses or net cash outflows, tax effects operate to reduce the overall loss. For a company that pays 30% taxes on income, a $100 operating loss (or net cost) also reduces the company's tax liability by $30. The net effect of the $100 loss on overall cash flow is thus $70. - When the business case includes capital assets, tax savings from depreciation improve the bottom line
Where the business case includes the acquisition of capital assets (either through purchase or capital lease), tax savings from depreciation can operate to increase overall cash flow. Depreciation expenses themselves do not contribute to cash flow: they are an accounting convention that impacts reported income, but not a real cash outflow. However, because depreciation expenses lower reported income, they also lower the tax liability, which does impact real cash flow. If a company claims $100 depreciation expense on an asset during the year, and if the company ordinarily pays a 30% tax rate on operating income, then the depreciation expense lowers taxes by $30 (that is, the net cash flow for the year is increased by $30).
Should you build an "after tax" or a "before tax" version of the financial business case? Sometimes one version is more appropriate than the other; in other cases, both versions are called for. Here are some factors to consider:
- How are other, competing proposals being presented?
When your proposals or plans compete with others, results need to be directly comparable to them, using the same approach to tax impacts. If presenting a before-tax case, however, take the trouble to understand what the "after-tax" case would look like, in case there's important information there that should not be overlooked.
- Which approach ("before" or "after" tax) means more to the audience?
If the case results are to be used by those who have responsibility for profits/profitability or overall company performance, an after tax version of the case should certainly be presented. On the other hand, where conformance to budget or budgetary planning are important considerations, a before tax version of the business case should be included. Managers at some levels of the organization may have much more interest on actual spending levels or sales revenues, and less direct interest in after tax profit levels. - What effect does adding or removing tax consequences have on business case results?
Tax effects can be especially important where different financing options are under consideration, as for instance in a "Lease vs. Buy" comparison, or when comparing a capital lease scenario with an operating lease scenario. In situations where before and after tax versions of the business case differ substantially—where tax effects on overall results are large—then tax planning itself may be an important management concern, and both versions of the case should probably be in view.
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