tax advisers are all familiar with the terms 'pretax earnings'
and 'after-tax earnings.' However, advisers sometimes fail to
perceive which measure is more relevant for business decision
making for a particular client.
differences in companies is crucial for advisers who want to
provide relevant advice and get important projects
companies are primarily valued in the marketplace based on
price-earnings multiples, which are based on pretax earnings.
However, one exception lies with companies that can materially
reduce income taxes compared to the other companies in the
market place by techniques such as inversion to a low tax
jurisdiction or achieving REIT status. These companies will be
typically assigned a higher earnings multiple in the stock
Many publicly traded
companies (particularly those that are pretax earnings
sensitive) will not authorize tax savings projects where the
costs of implementation are meaningful in relation to the cash
For example, suppose that a
company trading at a multiple of 15-times pretax earnings can
reduce its income taxes one time by $800,000 by spending
$100,000 pretax. Although that result may strike many as a
excellent cash-on-cash return, the publicly traded company may
not want to experience a $1.5 million reduction in stock market
value to save $800,000 in cash taxes.
Public companies that are
less sensitive to pretax earnings multiples due to their long
standing reputations or supportive concentrated owners are more
willing to consider and implement routine tax planning (such as
the above example) that not only reduces pretax earnings, but
also meaningfully increases after-tax cash flow.
Note however that a
publicly-traded company will typically be very open to a cost
reduction project that net of project costs will enhance pretax
earnings. To illustrate, using the same numbers from the above
example, a project that increases pretax earnings by $100,000
adds $1.5M in firm stock market value when using a 15-times
A goal of most
private companies is to increase enterprise after-tax cash flow.
A company with higher overall cash flow has more capital
available for all business opportunities, which may include
capital expenditures, marketing, acquisitions and owner
Sticking with the figures
in our example, most private companies would jump at the chance
to save $800,000 in taxes for a cost of $100,000 and would most
likely immediately authorize the tax project that enables them
to do take advantage of this savings.
One important exception to
the above scenario lies with private companies that are
preparing for a business sale, particularly if the expected
acquirer is a publicly-traded company. With a public company
acquirer fact pattern, the purchaser tends to be willing to pay
a higher multiple purchase price for a seller with higher pretax
earnings that will in turn increase the purchaser's total
enterprise value after the purchase.
before accountants and tax advisers attempt to have any tax and
non-tax projects authorized, they need to understand the
financial metrics important to their clients. The "money-saving"
or "cash-flow increasing" solution isn't always the ideal one,
depending on each company's financial goals.