Private equity refers to a method of obtaining business funds from private investors instead of from lending institutions. These private investors provide cash to businesses in hopes of getting a healthy return on their investment. Because these private investors need cash to keep doing business and making money, they often think in terms of cash. Cash-on-cash return measures the amount of cash an investment generates when compared to the amount of initial cash investment. This helps private equity lenders determine the profitability of their investments.
1. Calculate the amount of revenues generated by a certain investment over a year. For example, if an investment provides $5,000 per month in revenues, then the annual revenues are $60,000. Take the before-tax figure for this calculation.
2. Find out the amount of the initial cash investment. For example, if the private investor lent $600,000 to the business that generates the revenues, then the initial cash investment is $600,000.
3. Divide the annual cash revenues by the initial cash investment to get the cash-on-cash return. For example, with an annual cash flow of $60,000 and an initial investment of $600,000, the project has a cash-on-cash return of 10 percent ($60,000/$600,000).
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