Updated July 6, 2023
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 fail; 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 by summating 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, leading to 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.
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