Negative Cash Flow Meaning
Negative cash flow refers to the situation in the company when cash spending of company is more than cash generation in a particular period under consideration; This implies the total cash inflow from the various activities which includes operating activities, investing activities and financing activities during a specific period under consideration is less than total outflow during the same period.
In simple words, it means a business scenario when the firm spends more cash than it generates. This is a prevalent situation for firms in their growth phase as they need to spend money to fuel growth, acquire customers or may be set up distribution channels. In simple terms, it’s a game of numbers where the incoming cash is less than the outgoing money. In such a situation the deficit should be supported by equity infusion or debt funding or both.
This concept is not new but very much implicit in the calculations of cash flow. The simplest equation to understand this concept mathematically is understanding the negative cash flow calculation from core business activities.
Cash Flow = Cash Inflows – Cash Outflows
If this number is negative, it denotes a deficit and is termed as negative cash flow.
Basic Calculation (with Example)
Consider a firm XYZ with the following statement of cash flows.
At first glance, the company looks in a very bad state as the cash flow is $ -80,000. However, if we dive in further and rather than looking at the final cash flow number, we look at its various constituents, our perception of the current state of the business might change. The cash flow from operating activities is positive which suggests that the firm is doing good at core business activities. However, cash flow generated from investing and financing activities is negative. This might be because the management seeks good potential in future growth and wants to spend on it. For example, a large part of the money has been spent on buying additional equipment’s and plans which emphasizes that a firm is laying out plans for future expansion and growth.
Consider below the snapshot of cash flow from operating activities of internet Major Netflix. Looking at the final numbers it may seem like the firm is doing badly. However, diving in further reveals that the firm is trying to increase content on its portal which is leading to negative cash flow. This should be taken as a long term strategic initiative as part of growth expansion plans.
source: Netflix SEC Filings
Interpretation of Negative Cash Flow
- #1 – Negative cash flow is very much a part of the business – There is no business across the globe which has not faced such a situation. This might be a temporary situation that might have aroused due to the cyclic challenges to the business in which the firm operates or a new competitor entry, cash flow crunch due to some natural disaster or sudden regulatory changes.
- #2 – Better assessment of growth opportunities and evolve for the future – Negative cash flow is sometimes an indicator of how the firm is trying to expand and how aggressively it is doing so. It should be considered as an opportunity cost that the firm employs to draw out its expansion plans and execute them. In fact, it becomes imperative for the firm to grow and evolve else the ruthless completion will kill them. We have numerous such examples in history where the firms were not only cash-rich but also the market leaders. But they were too complacent and refused to evolve. Who can forget the words of Nokia CEO – “we didn’t do anything wrong, but somehow we lost.” They didn’t invest and adapt to the changing market conditions and were eventually acquired by Microsoft.
- #3 – Growth potential – It is an indicator of the financial health of the firm. If studied as a pattern, it can help investors in gauging their investments and calculate ROI. If the pattern suggests that negative cash flow is decreasing on a regular basis then it should suggest that the firm is recovering well, and the long term strategic growth is intact. However, if there is a cyclicity in a pattern, then it should suggest that external factors play a lot on the firm’s business. For example, crude prices weigh a lot on the airline business. This is certainly not a favorable scenario for investors.
- #1 – Cash Crunch – Negative cash flow can lead to a cash crunch which might, in turn, lead to a delay in payments to suppliers and vendors. This may affect your relationship with the vendors leading to poor service or even termination of contracts. Similarly, cash crunch situations can also force management to delay salaries of the employees. This can lead to a high attrition rate and loss of talent to competitors.
- #2 – Increased Bank Charges and Interest Rate Risk – As discussed above, negative cash flow must be funded by either the equity infusion or by debt funding. Debt finding comes with a cost as the interest has to be paid back. This can put constraints on the long term profitability of the firm. Also, there is an interest rate risk involved as the interest rate may rise in future leading to increased interest payout (in case of floating loans).
- #3 – Equity Dilution – If the external funding is done through equity infusion, it may be at the cost of diluting equity ownership which has its own implications. The decision making the power of the management is affected which makes it tough to implement long term strategic plans. Also, there is always a danger of a hostile takeover.
Unless the problem of negative cash flow becomes a common practice across multiple quarters, investors need not worry. It is very much part of business activities where firms have to sometimes spend more to evolve and find growth opportunities. However, investors should exercise caution as it can be a sign of a flawed business plan, lack of growth opportunities or rather a case of missed opportunities or can also be a fraud.
This has been a Guide to Negative Cash Flow and its meaning. Here we discuss the interpretation of Negative Cash Flow along with practical examples and disadvantages. You can learn more about accounting from the following articles –