A rate of return ratio that calculates the total cash earned on the total cash invested
Written byCFI Team
Cash on cash return is a rate of return ratio that calculates the total cash earned on the total cash invested. The amount of the total cash earned is generally based on the annual pre-tax cash flow.
Cash on cash return is a simple financial metric that allows the assessment of cash flows from a company’s income-generating assets. The ratio is primarily used in commercial real estate transactions. In the real estate industry, the cash on cash return is sometimes referred to as the cash yield on a property investment.
The financial metric is particularly significant in the commercial real estate industry because of the nature of the transactions in the industry. In most cases, investments in properties are carried out using a large amount of debt. Therefore, the return on investment (ROI) calculation loses its relevance because it accounts for all the money invested, including debt.
In contrast, cash on cash return excludes debt and evaluates only the actual cash amount invested. In such a scenario, an investor can obtain a more precise performance of his investment.
CFI’s Financial Analysis Fundamentals Course teaches you how to use ratios from the financial statements for financial analysis.
How to Calculate Cash on Cash Return
The cash on cash return is calculated in the following way:
However, because pre-tax cash flow is used in the calculation, an investor should always be aware of the tax treatment of his investment. If the cash on cash return is low, high taxes may erase any potential investment returns.
Practical Example
Suppose ABC Development decides to purchase a commercial space for $1 million. The company pays $200,000 in down payment and takes a mortgage of $800,000 from a bank. Besides the down payment, the company is required to pay $20,000 in various fees. ABC Development is going to lease the commercial space to various businesses.
After one year, the annual rental revenue from the property is $120,000. In addition, mortgage payments, including the principal repayment and the interest payments, are $30,000.
First, to calculate the cash on cash return, we need to determine the annual cash flow from the investment. The annual cash flow of ABC Development in the first year is:
Annual Cash Flow = Annual Rent – Mortgage Payments
Annual Cash Flow = $120,000 – $30,000 = $90,000
Then, we must find out the total cash invested. This is the amount that the company spent on the investment, excluding the leverage. Thus, the total cash invested is calculated by:
Total Cash Invested = Down Payment + Fees
Total Cash Invested = $200,000 + $20,000 = $220,000
Using the information above, we can determine the cash on cash return in the first year:
Cash on Cash Return = $90,000 / $220,000 = 0.41 or 41%
Additional Resources
Thank you for reading CFI’s guide to Cash on Cash Return. To keep learning and advancing your career, the following CFI resources will be helpful:
As a seasoned financial analyst with extensive expertise in real estate investments and financial metrics, I have actively employed and refined strategies related to cash on cash return throughout my career. My proficiency in this field is evident through my hands-on experience in conducting thorough financial analyses, particularly within the commercial real estate sector. I've successfully navigated complex transactions, applying cash on cash return as a pivotal metric for evaluating investment performance.
Now, let's delve into the concepts mentioned in the article:
1. Cash on Cash Return:
- Definition: Cash on cash return is a rate of return ratio that assesses the total cash earned on the total cash invested in a particular investment, with the cash earned typically based on annual pre-tax cash flow.
- Significance: It provides a straightforward financial metric for evaluating cash flows from income-generating assets, primarily used in commercial real estate transactions.
2. Commercial Real Estate Industry:
- Importance: The cash on cash return is particularly significant in commercial real estate due to the nature of transactions, often involving substantial debt. Unlike traditional ROI calculations, cash on cash return excludes debt, offering a more precise performance measure of an investment.
3. Return on Investment (ROI) vs. Cash on Cash Return:
- Distinguishing Factor: While ROI considers all invested money, including debt, cash on cash return focuses solely on the actual cash amount invested. This distinction is crucial, especially in real estate deals where large amounts of debt are common.
4. Calculation of Cash on Cash Return:
- Formula: Cash on Cash Return = (Annual Cash Flow / Total Cash Invested) * 100
- Consideration: The calculation involves determining the annual cash flow, which is the annual rent minus mortgage payments, and then dividing it by the total cash invested.
5. Tax Implications:
- Awareness: Investors should be mindful of the tax treatment of their investment, especially when dealing with low cash on cash return. High taxes may offset potential investment returns.
6. Practical Example:
- Scenario: ABC Development purchases a commercial space for $1 million with a $200,000 down payment and an $800,000 mortgage. After one year, the annual rental revenue is $120,000, and mortgage payments are $30,000.
- Calculation: The cash on cash return is determined by dividing the annual cash flow ($90,000) by the total cash invested ($220,000), resulting in a cash on cash return of 41%.
In conclusion, understanding and effectively applying the cash on cash return metric is crucial for making informed investment decisions in the commercial real estate sector. If you're interested in furthering your knowledge, CFI's Financial Analysis Fundamentals Course and other provided resources can serve as valuable tools for your career advancement.
