A cash-on-cash yield can refer to two main measures. The first is specifically related to the distributions from an income trust. The second is an extremely simple way of assessing the return from an income-generating investment, such as property. It simply consists of the pre-tax income from the investment in a set period, divided by the original amount invested. There are numerous limitations, making this is at best a snapshot.
Used precisely, cash-on-cash yield is the total amount of distributions from an income trust, divided by the trust's market value. An income trust is an investment vehicle where those making the investment decisions do so with the stated aim of producing consistent cash flows for investors, known as distributions. The precise rules governing an income trust vary from country to country and they are most commonly used in Canada and Australia. In this context the cash-on-cash yield is effectively the return an investor would make from investing in the trust. This is technically a hypothetical figure, as it compares returns made in the past with a purchase price to be paid now.
The more common use of cash-on-cash yield is for a measure also known as cash-on-cash return. This is a simple measure of pre-tax income from an investment compared with the investment amount. For example, if an investor buys a $200,000 US Dollars (USD) property and rents it out at $12,000 USD a year, the cash-on-cash yield is six percent.
This form of a cash-on-cash yield has some significant limitations. It does not take account of the tax the investor must pay on the income: this can vary from case to case and thus affect how attractive a particular investment really is. It doesn't take account of whether interest is simple or compound; the six percent return in the rental example above might not be as attractive in the long-run as putting the money in an investment that pays four percent interest that compounds over time. And by measuring only the immediate return, the figure takes no account of whether the investment asset's value changes, for example if the rental property's market price increases or decreases, affecting the ability to later sell it at a profit.
In both the specific income trust definition and the more general definition of cash-on-cash yield, investors should also be aware the figure doesn't distinguish between return on capital and return of capital. Return on capital is effectively a profit made on the investment. Return of capital means some of the money received by investors represents a loss in overall value of the investment vehicle or asset.
