Analysts dealing with companies that report operating losses should be aware of how the tax treatment of these losses can affect the company’s cash flow. Companies that have a substantially profitable record will probably recognize a tax credit in the year of loss and recover cash from previously paid taxes. Companies with relatively low profits, on the other hand, may be able to recover currently only a portion of the potential tax benefit; the remainder must be carried forward and will not be recognized until it is actually used to shield future profit from taxation.
Companies that have reported book profits in excess of tax return profits will experience the maximum disparity between the recognition of income effects and the timing of cash flows. In such cases, losses will probably be reduced by tax credits that are only partly backed by cash refunds; the balance will be represented by the elimination of previously recorded deferred tax credits.
