In this tutorial, you’ll learn what Deferred Taxes on the financial statements mean and how to project them in 3-statement models and valuations for different types of companies.
Table of Contents:
0:00 Introduction
0:33 The Short Version
5:30 Part 1: Net Operating Losses (NOLs) and Deferred Taxes
9:57 Part 2: Accelerated Depreciation and Deferred Taxes
13:39 Part 3: Stock-Based Compensation and Deferred Taxes
17:51 Part 4: Model and Valuation Treatment
20:04 Recap and Summary
Files & Resources:
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Lesson Notes:
Deferred Taxes usually arise because of items such as Net Operating Losses, accelerated Depreciation, Stock-Based Compensation, and Asset Impairments and Write-Downs.
Just as “Revenue” on a company’s Income Statement does not necessarily correspond to the cash received from customers since it is based on product/service delivery, “Income Taxes” on the Income Statement do not represent exactly what the company pays in Cash Taxes to the government in the period.
The “Deferred Taxes” line on the Cash Flow Statement bridges the gap between Book Taxes (“Taxes” on the Income Statement) and the Cash Taxes the company actually pays.
If Deferred Taxes are positive, the company pays LESS in cash to the government than its Income Statement suggests, and if Deferred Taxes are negative, the company pays MORE in cash to the government than its Income Statement suggests.
In models, the easiest projection method is to make Deferred Taxes a simple percentage of Book Taxes and continue whatever the historical trend was, such as Deferred Taxes being consistently positive, negative, or 0 (and if they’re random, just set them to a low percentage going forward).
However, if the company has a huge Net Operating Loss (NOL) balance, and you have the time, you may want to create a separate NOL schedule to track changes in this balance over time.
Net Operating Losses
When a company has negative Pre-Tax Income, it should still record Income Taxes based on Tax Rate * Pre-Tax Income, so Income Taxes will appear as a positive on the Income Statement.
But in reality, the company doesn’t get a “tax refund” - it simply pays nothing in Cash Taxes in the current period and accumulates losses it can use to reduce its tax burden in the future.
So, Deferred Taxes are usually negative when there’s a Pre-Tax Loss, so that the Cash Taxes are $0, and when the company starts earning Pre-Tax Income and uses its NOLs to reduce its Pre-Tax Income, Deferred Taxes turn positive to represent this tax savings and the fact that Cash Taxes are now less than Book Taxes.
If the NOL balance is small, you can simplify and assume slightly positive Deferred Taxes; if it’s larger, you may want to build a schedule (see the Uber, Snap, and Atlassian examples).
Accelerated Depreciation
With accelerated Depreciation, companies record higher Depreciation on assets in earlier years for tax purposes, under the argument that many assets are more useful in these early years.
For example, if it records $10 of straight-line Depreciation over 10 years for a $100 asset, it might record $25, $20, $15, $10, and $5 in each year after that for tax purposes.
In this scenario, the company’s “Tax” Operating Income and Pre-Tax Income are both lower in early years, so its Cash Taxes will be lower than its Book Taxes in early years.
As a result, Deferred Taxes are positive in the early years.
This reverses over time for a single asset, but in practice, most companies that use accelerated Depreciation tend to keep spending on new assets (CapEx), so Tax Depreciation will continue to exceed Book Depreciation going into the future.
As a result, these companies tend to record positive Deferred Taxes each year on the Cash Flow Statement.
Stock-Based Compensation, Impairments, and Write-Downs
With these items - paying employees in stock, options, or RSUs rather than cash and writing down the values of assets - the issue is that the expense is not initially deductible for Cash-Tax purposes.
It becomes deductible only when “Step 2” happens, such as the employees finally exercising their options or the company selling the written-down assets at a loss.
So, when the SBC or write-down is first recorded, the company’s Book Taxes fall but its Cash Taxes stay the same due to the lack of deductibility.
As a result, its Deferred Taxes are negative because Cash Taxes exceed Book Taxes.
If/when “Step 2” finally takes place, the company can deduct these items for tax purposes and record a positive Deferred Tax line to reflect it.
But since this timing is difficult to predict, in practice, most models for companies with high SBC tend to assume that there’s no tax benefit from it in the projected period, so Deferred Taxes are negative.
16 июл 2024
