A&M Tax Advisor Weekly
Here at A&M we see two important issues notably missing in the public discussion over the release of the Tax Cuts and Jobs Act. One issue pertains to investors and the other to tax leaders.
For Investors and Stakeholders: How Will Valuations Change?
There are at least two ways tax reform could significantly impact business valuations. Besides affecting future after-tax cash flows, tax reform means companies will also be immediately adjusting their financial statements.
Many companies have significant balance sheet items relating to tax, aka deferred tax accounts. For example, a net operating loss carry forward would be a typical large balance sheet asset. Companies value these deferred tax items using the income tax rate expected in the year of utilization. Hence, changes in enacted tax rates will consequently cause account values to change. If corporate rates decline, so will deferred tax asset and liability balances.
Besides shifts in tax rates, other changes in tax rules, such as taxation of foreign earnings, could also cause similar financial statement effects. (See the chart below for an example list of financial statement impact issues.)
Beyond affecting the size of an enterprise’s balance sheet and shareholder capital, these types of balance sheet adjustments will also affect many other important metrics, including…
– Leverage ratios,
– Bank covenant requirements,
– Regulated/statutory capital determinations,
…and perhaps most importantly:
– Equity/stock valuations.
Of course, tax reform would impact every organization differently depending on each company’s profile. This is especially true for the Tax Cuts and Jobs Act, which has business policy objectives behind it and hence affects different industries, operating models and ownership structures very differently.
While companies that disclose non-GAAP numbers might choose to omit the impact of reform from their press releases, stakeholders still need to know the implications in order to plan for potential valuation fluctuations based on GAAP earnings-per-share models.
For Tax Leaders: Will Financial Statements Be Ready?…