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How To Read A Cash Flow Statement In An Illinois Divorce
If you or your spouse own a business or part of a business, that business must be determined to be marital or non-marital for the purposes of division of assets in your Illinois divorce.
If the business was started, acquired, or built during the marriage, it is presumed to be marital and, thus, divisible. Interest in a business can be divided via stock in the business or one party can buy the other party’s marital interest in the business in order to effectuate an equitable division of assets. The income from each party’s share of the business will impact the division of other marital assets, child support, maintenance (formerly known as alimony) and college contributions.
If the business came into marriage whole, as it exists today, with one party to the divorce, the business is probably non-marital and will remain with the party that owned/owns the business. Likewise, the income of the business will still affect other issues to be resolved by an Illinois divorce court.
The first step to understanding a business’s income and value (which is largely determined by income) is to inspect that business’s cash flow statement.
What Is A Cash Flow Statement?
A cash flow statement is a summary of all the cash and cash equivalents (money) entering and leaving a company over a period of time.
Among the many financial reports that a company can issue, a cash flow statement is often seen as a more accurate financial report because a cash flow statement cannot be manipulated by non-cash transactions which are timed by the owners.
Because cash flow statements do not include depreciation, write offs of bad debt, deferred taxes and sales on credit that have not been collected yet, cash flow statements reflect more of a “boots on the ground” reality of what moneys the company has available at this very moment.
Sooner or later, all those issues have to be accounted for and will modify the final profit the company pays taxes on and distributes to shareholders.
In the meantime, the cash flow statement accurately reflects what cash is available now for the business to keep or spend.
What Does A Cash Flow Statement Not Tell You?
Cash flow statements tell a story about the business but there are important facts that a cash flow statement CANNOT definitely tell the reader.
A cash flow statement cannot tell you: 1) The profit earned (or loss suffered) by the business during the statement’s time period and 2) The financial health of the business at the end of the time period.
Profit earned by a business is a function of accounting which accounts for a multitude of factors to arrive at the actual taxable profit the business must pay. This is usually reflected in the business’s income statement
The overall financial health of the company refers to the assets of the business balanced against the liabilities of the business at the end of the time period. This concept is best revealed via the business’s balance sheet.
Both the actual profit when distributed as income to the owner-spouse (including salary) and the assets of the business are the relevant issues when determining child support, maintenance (formerly known as alimony), college contributions and division of marital assets.
Cash flow statements reveal little about the financial issues that are relevant and fundamental to finalizing a Marital Settlement Agreement in an Illinois divorce.
So, what can a cash flow statement tell a divorce litigant?
Cash Flow Statements In An Illinois Divorce
Cash flow statements must be tendered in an Illinois divorce pursuant to the issuance of the standard marital Notice To Produce, which instructs the other party to tender: “Any and all records, documents, payers and memoranda pertaining to moneys received and being presently received by you from all sources including, but not limited to, salaries, wages, draws, dividends, bonuses, sick pay, pensions or retirement funds, reimbursed expenses, return of capital, executive compensation, rents or proceeds of sale of capital assets, gratuities, gifts or loan proceeds used for living expenses.” If a party owns a business, these records will include a cash flow statement.
Cash flow statements reveal money available that may truly be income for the purposes of an Illinois divorce but is not treated as income for the purposes of taxation.
Cash Flow Statements can be compared against the business’s corporate tax returns.
A U.S. Corporation Tax Return, line 1a reflects the total sales of the company.
Line 2 of a U.S. Corporate Tax Return reflects the costs of goods sold.
These two lines should reflect similar amounts on the cash flow statement. If the sales and costs on both documents don’t correlate something is amiss.
Operating expenses will be listed on the cash flow statement and also on the U.S. Corporate Tax Return, lines 12-29. Again, these numbers should be approximately similar with obvious, traceable exceptions such as depreciation and money reserved for future use.
The expenses listed on the cash flow statement, the corporate tax returns and the party’s financial affidavit can all be cross-referenced for accuracy.
There will be a deviation between the two documents. A cash flow statement will not align perfectly with a corporate tax return. Instead, a cash flow statement shows the Net Income (on an Accrual Basis) or what’s left after you take sales, COGS, etc. It then adjusts for additional cash in and cash out as it pertains to Operating Activities (not Operating Expenses), Financing Activities, etc.
If the cash flow statement, the corporate tax returns and the party’s financial affidavit are not in agreement with each other, someone has some explaining to do. That “someone” is almost always the accountant who prepared the cash flow statement and the corporate tax returns and the way they can explain their findings to a divorce lawyer is via deposition.
These expenses summarized in a cash flow statement, listed in a corporate tax return and detailed in a divorce litigant’s financial affidavit must be examined carefully to determine if those expenses are not truly income to the business owner.
“For purposes of calculating child support, net business income from the operation of a business means gross receipts minus ordinary and necessary expenses required to carry on the trade or business.” 750 ILCS 5/505(a)(3.1)
Illinois divorce courts will add back in personal expenses covered by a business. Income shall include “[a]ny item of reimbursement or in-kind payment received by a parent from a business, including, but not limited to, a company car, reimbursed meals, free housing, or a housing allowance, shall be counted as income if not otherwise included in the recipient’s gross income, if the item is significant in amount and reduces personal expenses” 750 ILCS 505(a)(3.1)(b)
Furthermore, cash flow statements show cash available which may not be distributed as income to the owner via salary or dividends. This withheld operating cash is referred to as “retained earnings.” Retained earnings are not counted as income for the purposes of support…unless they are excessive. Excessive retained earnings can be considered as income by an Illinois divorce court.
“[R]etained earnings [are] necessary and appropriate business actions and [are] not excessive” In re Marriage of Moorthy, 2015 IL App (1st) 132077
Using the parties’ financial affidavit, the financial affidavit’s supporting documents (which could include a cash flow statement) an Illinois divorce court can make a determination of income for each party.
“[T]he circuit court has a duty to make its own calculation of a parties’ income.” In re Marriage of Evanoff, 2016 IL App (1st) 150017
“The court shall compute the basic child support obligation by…determin[ing] each parent’s monthly net income” 750 ILCS 5050(a)(1.5)
Illinois uses a formula for determining maintenance “if the combined gross annual income of the parties is less than $500,000…shall be in accordance [with guidelines]” 750 ILCS 5/504(b-1)(1)
When determining income for the purposes of calculating maintenance “the term “gross income” means all income from all sources, within the scope of that phrase in Section 505 [the child support section] of this Act” 750 ILCS 5/504(b-3)
The guidelines maintenance amount shall be “calculated by taking 33 1/3% of the payor’s net annual income minus 25% of the payee’s net annual income. The amount calculated as maintenance, however, when added to the net income of the payee, shall not result in the payee receiving an amount that is in excess of 40% of the combined net income of the parties.” 750 ILCS 5/504(b-1)(A)(1)
Combined income in excess of $ 500,000 shall result in a non-guidelines maintenance award. “Any non-guidelines award of maintenance shall be made after the court’s consideration of all relevant factors” 750 ILCS 5/504(b-1)(2)
Non-guidelines maintenance awards are where cash flow statements have real power in an Illinois divorce.
Illinois courts make non-guidelines awards based on “the income and property of each party”, “the realistic present and future earning capacity of each party” and “any other factor that the court expressly finds to be just and equitable.” 750 ILCS 5/504(a)(1, 3, 14)
The cash flow statement of a party’s business is very powerful evidence of the property and income of that party. A cash flow statement’s summary of available income may not be completely accurate but a non-guidelines maintenance award is not based on an accurate calculation, a non-guidelines maintenance award is based on whether the income is there or not…which the cash flow statement proves.
How To Get A Cash Flow Statement Into Evidence
A cash flow statement is an out-of-court statement used to prove what it says: how much money is coming into the business and how much money is going out of the business. That is hearsay and is not allowed as evidence in an Illinois court.
Furthermore, the cash flow statement is not the data itself but rather is a summary of the data. That makes a cash flow statement a demonstrative exhibit. To introduce a demonstrative exhibit, you must first authenticate the underlying data.
You’re going need to bring in the accountant who prepared the cash flow statement and certify the accountant as an expert witness so that he can offer his opinion (the case flow statement) into evidence.
Whether you own a business or your spouse owns a business, someone is very savvy. Savvy people need a savvy lawyer. People who are married to a savvy person REALLY need a savvy lawyer. Contact my Chicago, Illinois family law firm to learn more about how to understand financial reports during your Illinois divorce.