Negative cash flow is a financial incident that happens in almost every business when company expenses exceed the income.
It is a bad sign for the company’s future growth and should be fixed as soon as possible.
In this article, you will learn everything about negative cash flow, including what it is, why it happens, real-life examples, and how to manage it.
What is negative cash flow
Negative cash flow occurs when a company’s expenses exceed its income.
In other words, the company’s outgoing cash is more than its incoming cash, meaning the company is spending more than it earns.
It is necessary to address this issue because it can harm the business in the long term.
However, NCF is not always bad. It is possible for a firm to face negative cash flow but still be profitable.
Also, you should find out the reasons why NCF occurred. Startups may have negative cash flow initially because they invest heavily in equipment.
Mature companies face this situation when professionals decide to reinvest in assets for future growth. This is categorised as Investing Negative Cash Flow.
However, when NC persists for a long time period, it means the company’s financial condition is poor and should be fixed as soon as possible.
Explanation of Cash Flow
A cash flow statement is a company financial report that lists all the cash inflows and outflows.
Cash flow is the net of cash inflow, where cash is coming in, and cash outflow, where cash is going out.
Cash flow = Cash Inflow – Cash Outflow.
The cash flow statement is divided into three sections:
- Cash flow from operating activities
- Cash flow from investing activities
- Cash flow from financial activities
Generally, negative cash flow occurs due to operating activities, which are related to a business’s core operations. It happens when the expenses of the business exceed the net sales of the company.
NC is not always a bad sign. However, if it persists for several months and the company does not gather sufficient funds for growth, then it becomes a real problem.
Effects of Negative Cash Flow
Here are some negative effects that occur during negative cash flow:
Business Running: The main effect of negative cash flow is that the company does not generate enough cash to pay its expenses, which could lead to the business shutting down in the near future.
Investors: Investors are interested in companies showing positive signs of growth. It’s common sense that investors are only interested in profitable businesses.
Cash Crunch: When a company lacks sufficient cash, it may delay paying suppliers and lenders, affecting the credibility and relationships of the company.
Interest: Debt funding is based on interest rates, and if payments are delayed, the company will pay more money to lenders due to high-interest rates or late fees.
Growth: While you may cover all expenses, in negative conditions, the business only survives. For business growth, you need to spend money on research and development.
Why Negative Cash Flow Happens
Here is reasons:
1. Unexpected Expenses
One reason for negative cash flow is the sudden rise in unexpected expenses, such as equipment repairs.
In an ideal world, companies operate with a theoretical plan, but the practical world presents unforeseen situations. When companies face unexpected expenses like equipment maintenance or insurance premiums, it leads to significant cash outflows.
2. Bad Product Pricing
Product pricing can be a primary reason for NCF, often overlooked. Poor pricing affects net sales, directly impacting cash flow. If product or service prices are not balanced with customer or market value, it can result in negative cash flow. High prices compared to market rates may deter customers, leading to decreased sales and cash flow.
Conversely, low prices may attract customers, but profit margins may be insufficient to cover expenses, resulting in low cash inflow. Both scenarios contribute to low cash inflow, potentially failing to meet company expenses. Therefore, finding the ideal price for products is necessary.
3. Weak Financial Plan
A weak financial plan is another major reason for negative cash flow. A strong financial foundation is crucial for company growth.
If a good financial plan is not created for the business, it can lead to NCF. While investment is beneficial for business growth, investing in unnecessary items such as extra equipment, services, or property can deplete funds without boosting the company’s growth.
4. Delayed Customer Payments
Providing sales on credit can increase sales and assist customers, but large amounts tied up in credit can harm the business.
Delayed customer payments extend payment terms, while the company still needs to pay vendors for raw materials and other business expenses.
Managing Negative Cash Flow
We’ve discussed what NCF is and its underlying reasons. Now let’s explore how to manage negative cash flow for your business:
1. Identify the Source
Negative cash flow can stem from various reasons, so it’s crucial to pinpoint the source of the issue.
Negative Operating Cash Flow: Determine the operational cash flow by subtracting payable from receivable. If the value is negative, it indicates low income and poor sales. A positive value suggests income not aligning with expenses.
Negative Cash Flow from Assets: Negative cash flow from assets is common for new companies investing heavily in fixed assets. Alternatively, companies may reinvest heavily in assets for future growth.
For example, in 2018, ExxonMobil had negative investing cash flow, spending approximately $19.5 billion on plants, equipment, and property, while generating only $4.12 billion in sales.
2. Negotiable Terms and Conditions
Adjusting the terms regarding customer payments and vendors’ payments can also help manage cash flow.
Reduce the due date for customers who purchase products on credit. Decreasing payment terms from 45 to 30 days can expedite cash inflow.
On the other hand, negotiate for extended payment terms with vendors and suppliers. Utilize maximum payment days and negotiate favourable terms for long-term payments.
Also, explore the market for better deals; it is possible that other suppliers have more favourable terms compared to the current ones.
3. Look at Unnecessary Expenses
While reducing expenses can be challenging, it is essential to review outgoing expenses and identify unnecessary items. Distinguish between overhead costs and operating expenses for clarity.
Many companies overlook unnecessary expenses. By closely examining the cash flow statement, you may find several expenses that are currently unimportant. For example, excessive spending on inventory is not advisable.
Professionals should cut unnecessary spending on inventory. However, it is crucial to remember not to cut essential items required for running the business, as it may work against the company.
4. Monitor and Forecast Cash Flow
One reason for negative cash flow is the lack of monitoring by the company. It is beneficial to always monitor cash flow. One of the best ways to address this problem is by creating a forecasted cash flow.
Forecasting cash flow provides insight into how your company’s cash inflow and outflow performance will look in the future. This allows the team to make better decisions and plans for how to spend money and tackle current problems effectively.
5. Find a Loan
If you struggle to manage cash flow and do not have sufficient funds to run the business, consider financing options such as loans. Small business owners can apply for small business loans under the SBA system.
It is a quick way to address negative cash flow. However, it is important to repay the loan in the future.
Conclusion
In conclusion, while negative cash flow may not be detrimental in the short term, persistent it requires attention and resolution. Regular monitoring of cash flow is essential to identify and address issues promptly.
Furthermore, gaining knowledge about financial details beyond cash flow management contributes to overall business growth and success.
Explore additional resources
cash flow direct method: how to calculate it