Definition
Cash on Cash Return is a financial metric that calculates the cash income earned on the cash invested in a property or business. It’s typically used in real estate transactions and is calculated by dividing the annual pre-tax cash flow by the total cash invested. It essentially measures the return on the actual cash invested rather than the return on total investment cost.
Key Takeaways
- Cash on Cash Return is a metric used by real estate investors that evaluates the cash income generated in relation to the amount of cash invested in a property. It provides a clear picture of the profitability of real estate investments.
- This financial term is particularly useful for investors who wish to compare the performance of different investment properties before making decisions, as it provides a transparent calculation of annual pre-tax cash flow to the total amount of cash invested.
- Cash on Cash Return does not account for non-cash factors such as property appreciation or depreciation, or non-cash expenses like property taxes, which can be a limit in its scope of analysis. Hence, it is best used in conjunction with other metrics for comprehensive investment evaluation.
Importance
The finance term, Cash on Cash Return, is crucial as it provides investors with an analysis of the business performance by evaluating the cash income earned on the cash invested in a property.
This metric is typically used in real estate transactions and provides an accurate assessment of an investment’s profitability.
It takes into consideration both the annual pre-tax cash flow of the investment and the total cash invested, thus enabling investors to understand the cash yield from the asset, and compare the relative value of different investment opportunities.
Hence, Cash on Cash return is an invaluable tool for investors, allowing them to make informed decisions based on the cash return on investment.
Explanation
Cash on Cash Return is a financial metric widely used in the realms of investment and real estate to assess the profitability and performance of an investment based on the actual cash income earned. This financial metric’s primary purpose is to evaluate the cash income against the cash invested.
In essence, it shows an investor the rate at which their cash investment is generating cash flows – this is particularly useful for properties that require a significant amount of cash investment upfront or ones that are financed using debt. The insightful data obtained from the Cash on Cash Return formula is crucial for investors in property, as it helps them understand the income they’re making in relation to the cash invested.
By providing a clear perspective on the true returns of a property, it enables investors to compare different investment opportunities more accurately. Investors can use this ratio to make informed decisions about their investments’ effectiveness, keep track of their cash flow, and manage their investment portfolios more efficiently.
It is also an excellent determinant of risk versus yield, enabling investors to determine if the investment aligns with the level of risk they’re willing to take.
Examples of Cash on Cash Return
Real Estate Investment: Perhaps the most known use of the Cash on Cash Return metric is in real estate investment. For example, an investor buys a property for $300,000 using a $60,000 down payment and borrowing the remaining $240,Assuming the property generates net operating income of $24,000 per year, your Cash on Cash Return would be $24,000 (net annual cash flow) / $60,000 (initial cash investment) =
4 or 40%. This means that each year the investor is earning 40% of their initial investment back.Restaurant Business: A man invests $200,000 to open a restaurant. At the end of the first year, his profit after all expenses is $40,
This makes his Cash on Cash Return 20% (40,000/200,000).Stock Investment: A person invests $10,000 in a company’s stock, which pays annual dividends. Assuming the company pays $500 in dividends at the end of the year, the Cash on Cash Return will be $500/$10,000 =
05, or 5%. This means that the investor has received 5% of their initial investment back in a year.
Frequently Asked Questions about Cash on Cash Return
What is Cash on Cash Return?
Cash on Cash Return is a financial metric used in the real estate sector to measure the cash income earned on the cash invested in a property. It is calculated by dividing the annual pre-tax cash flow by the total cash invested.
How is Cash on Cash Return calculated?
To calculate Cash on Cash Return, divide the annual pre-tax cash flow by the total cash invested. This gives you a percentage that represents the return on your investment.
Why is Cash on Cash Return important?
Cash on Cash Return is an important metric because it provides an accurate analysis of the investment’s performance. This helps an investor to know whether the investment is worthwhile, and provides a way to compare different investment opportunities.
What is a good Cash on Cash Return?
There isn’t a definitive answer to what a “good” Cash on Cash Return is as it largely depends on an investor’s individual situation and risk tolerance. However, generally speaking, a Cash on Cash Return of 8 – 12% is considered good in the real estate investment community.
Is Cash on Cash Return the same as Return on Investment (ROI)?
No, Cash on Cash Return and ROI are slightly different. While both are important measures of an investment’s performance, ROI takes into account all profits and costs associated with the investment, while Cash on Cash Return only considers the cash income relative to the cash invested.
Related Entrepreneurship Terms
- Capital Expenditure
- Net Operating Income
- Investment Property
- Annual Pre-tax Cash Flow
- Real Estate Investment Valuation
Sources for More Information
- Investopedia: A comprehensive online financial dictionary. Articles are written by experts and contain clear explanations of financial concepts.
- Fidelity Investments: A multinational financial services corporation. It provides a variety of online resources and information about financial concepts.
- Morningstar: An investment research and investment management firm. It provides various resources and tools to better understand and manage financial and investment terms.
- The Balance: Provides clear, practical advice to help you make the best decisions with your money. It provides various articles and financial explanations.
