Cash Charge

You may have heard of a company shutting down a business unit and laying off employees while taking a “one-time” cash charge to their earnings. This is generally accompanied by a large cash outflow to cover severance payments to employees, and perhaps funding early retirement packages. Hopefully, this one-time expense is made up for by cost savings through reduced salary expenses.

A cash charge appears as an extraordinary expense on the company’s income statement and reduces net income, which should also result in lower taxes. However, the outflow of cash to pay for all the severance packages, etc. will reduce the amount of cash on hand on the company’s balance sheet.

Example.

General Chaos Inc. decides to automate its call center, and will replace 400 employees with a $10,000 computer. Since the workers are unionized, GC will have to pay one year’s salary to each employee...so they take a one-time cash charge of $20 million. There will be a large outflow of cash to pay the salaries, but going forward they will hopefully save $20 million in salaries per year by relying on the computer. (Now no one will ever be able to reach a human being.)

A cash charge is very different from a non-cash charge. Non-cash charges refer to writing down the value of intangible assets, such as patents or stock-based compensation. There is no cash outflow, because the assets are intangible, but there is still an extraordinary expense charged on the company’s income statement that reduces net income. However, there will be no effect on the cash amount on the balance sheet.

The gaming company We Are Virtually Successful Inc. thought their patent for virtual reality games was worth $100 million. When that didn’t pan out in the marketplace, they had to write down the value of the patent to $10 million, taking a non-cash charge of $90 million on their income statement earnings. However, the cash amount listed on the balance sheet will remain unchanged, because there was no “real” outflow of cash.

Be on the lookout for companies that take “one-time” cash charges frequently. These charges are usually not included on a “pro-forma” earnings statement (earnings that don’t include certain costs), so some companies like to take a lot of one-time charges to make their financial health look better than it is.