Cash on cash return, also known by its acronym CCR, is an investing term. It describes a ratio of the yearly cash flow before taxes against the total sum of cash invested. This cash on cash return is expressed as a percentage.
Cash on cash return is mostly utilized to analyze any income generating asset’s actual cash flow situation. This percentage is commonly applied as a simple and quick test to decide if an asset under consideration is worthy of additional study and analysis. An investor who believed that cash flow is the greatest goal would be most interested in an analysis based on cash on cash return. Others employ it to discover if a particular property or asset turns out to be under priced. This would mean that equity in a property would exist immediately upon purchase.
Cash on cash return formulas do not figure in any deprecation or appreciation of an income producing asset. This means that the cash on cash return number may be skewed to the high side if some of the cash flow produced turns out to be a return on capital. This is because return on capital is not income.
Another limitation to cash on cash returns as a measurement lies in the fact that the calculation is more or less one of simple interest. This means that it does not take into consideration the compounding of interest. As a result of this, investments that provide a lower compound interest rate might be better over time than those that provide greater cash on cash returns, which is only a simple interest calculation.
A last downside to using cash on cash returns as a means of evaluating an investment centers around the fact that they are only pre tax cash flow evaluations. This means that your tax situation as a unique investor will not be considered in the formula. Varying tax situations can determine if an investment is a good match for you or not.
Consider an example of figuring up out a cash on cash return. You could buy an apartment complex for $1,200,000 using a down payment of $300,000. Every month, the resulting rental cash flow after expenses for this property is $5,000. This means that in a year, the income before tax would amount to $60,000, as $5,000 was multiplied by twelve months. This would make the cash on cash return the cash flow for the year before taxes of $60,000 over the entire amount of money invested in the asset of $300,000. This results in an actual twenty percent cash on cash return.