In loss utilization carry forward, we can offset current losses against future profits.

Let's use a numbers example.

Here we have an income statement extract, and I can see a profit before tax or loss. In this case of negative 100, the tax authorities say instead of having a tax expense, we will have a tax credit of Positive 30.

Now, importantly, we won't get a cash refund of tax this year.

No. But if we can make profits in the future, we can use the tax credit here to reduce future profits and get a cash tax benefit in the future.

Great. So year zero losses create a tax credit on the income statements matched by deferred tax assets or DTA on the balance sheet.

The balance sheet accounting entry would be DTA or deferred tax asset up and retained earnings or re up in year one.

Here we have a profit.

We have not included the losses yet.

The profit before tax is 300, creating tax expense of 90, which is 30% tax rate on the 300 and a net income of 210.

So in year one, when we produce profits like here, we can use the year zero losses to reduce year one tax paid.

But importantly the accountants will say, we've made a profit before tax of 300.

We need to actually show that we can't pretend it was 200 by taking last year's losses and netting them together with this year's profits And the tax expense of 90.

That's correct. That is the tax expense on the 300 and the net income of 210 is correct.

So the accountants, they're happy with the income statement as it is.

They don't want these numbers to change, but we want to use the tax losses.

So how can we include the tax losses? Now we have year one, including the tax losses and the tax authorities have allowed us to use the tax credit to reduce current year tax expense from 90 down to 60.

This is the important item because it means less tax will be actually paid.

The cash flow really changes From 90 down to 60.

Great. We've carried forward the benefit from the tax losses, but the accountants, Hmm, they want to see tax expense stay at 90.

So we reduce the deferred tax assets from 30 to zero and instead have a deferred tax expense on the income statement of 30.

This makes the total tax expense to 90 again, and net income remains at 210.

So in summary, in year one, the cashflow statement has less tax paid.

Great. The balance sheet, DTA or deferred tax asset reduces and net income on the income statement is the same.

Now for those interested in the accounting, the deferred tax asset going down is matched by the retained earnings going down by the deferred tax expense of 30, appearing on the income statements while the cash going up due to less tax being actually paid.

Remember we thought we would pay tax of 90, but it was actually 60 that's matched by the retained earnings going up due to less current year tax expense.

Again going from 90 to 60.

So we can see here the two retained earnings effects.

Well, they cancel out.

So the short version of the accounting is the deferred tax asset goes down and cash goes up.

Effectively, we use the deferred tax asset from the past losses to pay less cash tax in the future.

A few extra things to remember when carrying forward tax losses.

Firstly, you can have time limitation on carry forwards.

If the company with a deferred tax asset reduces its forecast for future profits, then you may have to write down the deferred tax asset as it won't get utilized.

Imagine we had a huge deferred tax asset in year zero, maybe for for a thousand or many thousands, and I want to use that against future profits, maybe 100, 100, 100 each year.

Well, that's going to take me at least 10 years to offset that 1000 or many thousand of losses against the 100 of profits every year.

If my profits are only 50 each year, it'll take me 20 years plus tax authorities aren't happy about this.

So there is often a time limit Imposed.

The second thing is that there is an accounting impact.

Carry forwards can have a big impact on the balance sheet and the cashflow statement as well.

But remember, no overall impact on the income statements.

And lastly, there can be an m and a impact.

An acquisition can mean deferred tax assets gets used up faster, increasing the value of the targets.

How does this come about? Well, imagine I'm going to buy a company and that will give me synergies in my company.

Synergies mean my profits go up and thus I can use up a deferred tax asset faster.

Instead of spreading a deferred tax asset over maybe 10 years of future profits, I could perhaps use it up over five years.

That means I'll get cash flows sooner, which will increase the DCF or discounted cash flow of my company, increasing the company value.