“Negative cash flow” refers to a condition where a firm, for a period of time, is seeing more cash leave the organization than comes into it. This does not necessarily mean cash loss, since income could be in the future, as represented by receipts receivable. Only when cash flow problems become chronic is there most likely a realized loss. Cash is ready money, not credit or capital. Therefore, a negative cash flow need not be associated with a business doing poorly.
If a firm invests heavily in productive capacity in expectation of market expansion, this can lead to negative cash flow if the market fails.There might be short-term cash issues if the new capital takes some time to get online. Any investment that takes time to begin functioning to its full potential will cause short-term cash flow problems. If the market is depressed for the long run, new equipment might become a chronic cash flow problem.
Maintaining too much inventory can cause a problem. This is especially the case if the inventory needs to be cared for, such as animal stock, produce or anything that needs to be refrigerated or heated. While, sometime in the future, this stock might produce income, for the short term, the overstock of inventory items can appear on a balance sheet as requiring too much cash to maintain or store.
Even stable and mature firms want to expand. In nearly all cases, in the short term, new investment and plant expansion will lead to negative cash flows. Under many circumstances, this negative flow will soon be reversed, but if the market cannot absorb this expansion, the negative cash flow might be permanent unless the new material can be quickly sold off. When a firm expands too quickly, many sources of financing might get worried that the firm is overextending itself. Overoptimistic planning can lead to serious problems for cash flows, at least in the short term.
Strange as it might seem, firms operating in rapidly growing or expanding markets often eat up cash. This is because expansion is constantly on the agenda, and short-term financing is going to fund it. The constant use of cash on hand leads to negative cash flows, but it also serves to show that the business is successful. It is when the credit of a firm starts to decline that investors begin to worry. Lots of cash on hand might even be a sign that the firm is doing poorly, since the cash has little to do. If anything, it might be “on hand” as a reserve to pay employees if sales continue to flatten or fall. For firms with negative cash flows, this might be more than compensated for by expansion in capital and credit increases.
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