Negative Cash Flow


Definition of Negative Cash Flow

Every business is undertaken to generate positive returns alongside attaining the broader business objective. Negative cash flow refers to the situation where the cash outflow by the company exceeds its cash inflow resulting in a net cash outflow for the business as a whole. This happens when a business burns more cash than it earns, and multiple reasons lead to such a situation. It is pertinent to note that just having negative cash flow doesn’t make a business failure; one needs to understand the reason for negative cash flow and the period to which it continues to make better-informed decisions.

Explanation

Businesses generate net cash flows through the summation of these activities: Operating, Investing, and Financing. Negative cash flows mean overall spending for a particular period is more than Overall earnings. Thus negative cash flow, in short, means spending more than earned.

Generally, at the initiation of business, it is normal to have negative cash flows as this is when the company is investing in itself with minimal or no revenue visibility (leading to negative operating cash flows) and negative financing cost ( interest on debt borrowing ).

Negative Cash flow=Total Cash Outflow> Total Cash Inflow

A fundamental example illustrating negative cash flows is shown below:

ABC Limited made a total revenue of $12000 during the year and incurred total expenses of $15000. All the revenue and expenses are of a cash nature and paid during the same year itself.

Based on the above, we can see the business has a negative cash flow of $3000

  • Negative Cash flow=$15000>$12000
  • Negative Cash flow =$12000-$15000 = ($3000)

Examples of Negative Cash flow

Let’s understand the same with the help of a more comprehensive example.

Crave International is a fast-growing company with operations across multiple jurisdictions. The company has presented below its cash flow summary comprising its inflows as well as outflows across various sources:

Crave International Limited

Quarterly Cash Flow Statement (Amt in USD)

Particulars Actual Quarter Quarter Quarter Quarter
31.03.2019 30.06.2019 30.09.2019 31.12.2019 31.03.2020
INFLOWS
Project Inflows 57,336 12,564 12,564 12,564 12,564
Sales of Food & Beverages 275 275 350 350
Public Deposits(Net) 10,872 775 775 775 803
Capital & Reserves 37,059
Creditors 20,009 623 623 623 622
Dividend Payable 556 -556
Deferred Tax Liability 2,506 494
Current Liabilities 5,168 150 150 350 527
Term Loan from
From Banks 1,118 194 101 140
From Ratnakar Bank 4,000
From Sicom 8,500
From Other Corp Bodies 18,232 3,500 9,000 4,000 2,000
Debentures
Other Term Liabilities 488 300 300 300 112
Other Income 150 175 200 225
Income on sale of shares
Income Tax Provision
Depreciation 2,268 -17
TOTAL INFLOWS 1,64,111 18,337 24,057 22,707 17,822
OUTFLOWS
Project Payments 1,29,041 16,968 19,468 24,468 16,968
Food, Beverages, and Other Expenses 165 165 165 165
Administrative Expenses 1,640 1,640 1,640 1,640
Interest Payments 1,200 1,200 1,200 1,200
Repayment of Term Loan
To Banks 232 228 65 65
From Ratnakar Bank
To Sicom 500 500 750 750
To Other Corp Bodies 1,999 1,231 923 1,393
Debtors 16,691 -4,173 -4,173 -4,173 -4,173
Raw Materials 3,152
Finished Stock 1,023
Advance Income Tax 151 410 410 410 410
MAT
Fixed Assets 7,246 100 100 100 54
Investment in Subsidiary Companies 2,293 152 33
Other Investments 0
Loan to Geo Connect Ltd. 500
Long-Term Loans & Advances 104 46 50 50
Other Current Assets 7,423 -224 -224 -224 -224
Cash & Bank balance 3,553 24 24 24 24
Total Outflows 1,71,176 18,992 20,647 25,398 18,321
SURPLUS(+)/DEFICIT(-)        (7,064)            (655)          3,409        (2,690)            (499)

As we can observe, the business has Negative Cash flows in three out of four quarters of 2019-20.

Reasons for Negative Cash Flow

It is a common question why the business has negative cash flow and will continue with negative cash flows.

Businesses can have negative cash flows for multiple reasons:

  • First, lower Sales Revenues with fixed operating expenses lead to negative cash flow.
  • Higher cash outflow in investing activities for future growth. This can be in the form of higher advertisement spending to improve visibility or investment in new technology.
  • Higher financing cost is another reason behind the negative cash flows. It is observed in many businesses that high-leveraged bets are undertaken to scale up the business. In an economic downturn, revenues don’t increase to the extent to make the company serve interest costs, leading to negative cash flow.

Effect of Negative Cash Flow

  • The impact of negative cash flows depends on the time it continues and the reason for which the same happens. These two factors determine their effects and consequences.
  • Negative cash flow for a smaller period caused by a temporary demand blip or slowdown in the economy can be overcome by the business as these are part and parcel of business and don’t impact the company’s long-term sustainability.
  • Secondly, the negative cash flows due to declining sales, increased fixed operating expenditure, outdated technology, and so on need to be identified, and corrective action is to be taken.
  • In short, it affects the sustainability and survival of the business; however, if the same is for a short-term and non-repetitive, the company can overcome the same through better-managed finance and keeping a cushion of retained earnings to overcome such periods of negative cash flows.

Advantages of Negative Cash Flow

Burning cash more than earning hardly has any advantages prima facie; however, if negative cash flow offers the following, then it can be construed as the advantage of the same:

  • Negative cash flows are because higher investment in business expansion is considered positive.
  • It leads to lower tax outgo for the business, which indirectly is cash flow positive.

Disadvantages of Negative Cash Flow

  • It challenges the business’s survival, and investors usually avoid investing in companies with consistent negative cash flows as those are wealth destructors.
  • Companies with negative cash flows find it hard to raise capital through equity financing or debt, which leads to either lower business valuation or higher interest costs.

Conclusion

Cash flow is the heart of the business, and negative cash flow is something every company wants to avoid until and unless it is undertaken with the intent of future growth prospects. Most successful startups have initially been negative cash flows; however, they generated a lot of wealth for investors with time. Thus it should not be read just in isolation but be understood in totality, and accordingly, investors and other stakeholders should take a call to make better-informed decisions.

Recommended Articles

This is a guide to Negative Cash Flow. Here we also discuss the definition, reasons for negative cash flows, and advantages and disadvantages. You may also have a look at the following articles to learn more –

  1. LIFO Reserve
  2. LIFO Liquidation
  3. First in First Out
  4. FIFO vs LIFO

The post Negative Cash Flow appeared first on EDUCBA.



Source link

Leave a Reply

Your email address will not be published.