In investing, the cash-on-cash return is the ratio of annual before-tax cash flow

Cash flow

Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.Cash flow...

 to the total amount of cash invested, expressed as a percentage.

It is often used to evaluate the cash flow from income-producing assets. Generally considered a quick napkin test to determine if the asset qualifies for further review and analysis. Cash on Cash analyses are generally used by investors looking for properties where cash flow is king, however, some use it to determine if a property is underpriced, indicating instant equity in a property.

Example

Suppose an investor purchases a $1,200,000 apartment complex with a $300,000 down payment. Each month, the cash flow from rentals, less expenses, is $5,000. Over the course of a year, the before-tax income would be $5,000 × 12 = $60,000, so the cash-on-cash return would be

.

Limitations

• Because the calculation is based solely on before-tax cash flow relative to the amount of cash invested, it cannot take into account an individual investor's tax situation, the particulars of which may influence the desirability of the investment. However the investor can usually deduct enough Capital Cost Allowance
  Capital Cost Allowance
  Capital Cost Allowance is effectively the means by which Canadian businesses may claim depreciation expense. Depreciable items are deemed to belong to different classes which depreciate at different rates and are subject to different rules...
  
   to defer the taxes for a long time.
• The formula does not take into account any appreciation
  Appreciation
  In accounting, appreciation of an asset is an increase in its value. In this sense it is the reverse of depreciation, which measures the fall in value of assets over their normal life-time...
  
   or depreciation
  Depreciation
  Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
  
  . When some cash is a return of capital
  Return of capital
  Return of capital refers to payments back to "capital owners" that exceed the growth of a business. It should not be confused with return on capital which measures a 'rate of return'....
  
   (ROC) it will falsely indicate a higher return, because ROC is not income.
• It does not account for other risks associated with the underlying property.
• It is essentially a simple interest calculation, and ignores the effect of compounding interest
  Interest
  Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
  
  . The implication for investors is that an investment with a lower nominal rate of compound interest may be superior, in the long run, to an investment with a higher cash-on-cash return.

It is possible to perform an after-tax Cash on Cash calculation, but accurate depictions of your adjusted taxable income are needed to correctly address how much tax payment is being saved through depreciation and other losses.