Question

How does stock based compensation hit the cash flow statement and how can i calculate the impact?

Answer 1

Stock based compensation is basicaly a non-cash transaction. and many companies specially those follows the rules of IRS accounting standard do not count it as an expenses as IRS doesn't recognize non-cash stock compensation.

However many companies that follows GAAP accounting do count it as an expenses and include it in the "Income Statement" to lower that Tax in the future and records it as a "Deferred Tax in the "Cash Flow Statement".

For example:

Abc Co. has a "Gross Profit" of $600000, and Stock based Compensation of $55000, then the "Income before Taxes will be ($600000 - $55000 = $545000) and the Tax Rate is considered to be 35%

Hence, the Provision for Income Tax Expenses = $545000 x 35% = $190750

Ie- the Income after Tax = 545000 - 190750 = $354250

However IRS will not deduct the Stock based compensation thus the Net Income will be on $600000

Ie- Provision for Income Tax = 600000 x 35% = $210000 (Resulting in higher Tax Expense)

Ie- the Income after Tax = 600000 - 210000 = $390000

And the diferrence beween these two taxes will be the "Deferred Tax Asset" that is shown in the Balance Sheet as its a future Gains that is yet to be claimed.

Deferred Tax Asset = 210000 - 190750 = $19250

Hence we can see the Impact on the Cash Flow from Operation resulting in greater CFO wrt the Net Income computed based on GAAP.

For Example:

Operating Activities	20xx
Income After Tax	$354250
Stock Compensation Expenses (Non-Cash hence added back)	55000
Less: Deferred Tax Expenses	(19250)
Cash Flow from Operation Activity	$390000

As computed above we can see that the "Operating Cash Flow" tally with the "(IRS) Net Income" as is greater than the "(GAAP) Net Income", this reflects the Non-Cash nature of Stock based Compensation. And such method of Accounting in financial statements impacts a Company's financial performance on how they manage to improve their interpretation of the effect that Stock based Compensation has on the company, as shown in the above example how a company reports its Stock Compesation Expense in financial statements to lower its tax expense by deducting it from Income Statement and creating a "Deferred Tax Asset".