Learn something new every day
More Info... by email
Negative cash flow occurs in a business when the outflow of cash payments exceeds the inflow of cash from sales. The most common reasons for this problem include high operating expenses, low sales volume, improper cost accounting, poor investments made into assets and unattractive financing options made with lenders. Many businesses can implement a few procedures for improving cash flow. Allowing negative cash flow to increase to unsustainable levels will result in the company coming closer bankruptcy. In some cases, the company may be unable to correct cash flow problems, leaving bankruptcy as the only option.
The statement of cash flows is the most common tool for companies to use in determining why they have a negative cash flow problem. This statement is necessary for all companies using an accrual accounting system. Most businesses use the accrual accounting system, as national accounting standards have strict requirements for the accrual system. The statement of cash flows has three sections: operating, investing and financing. Each section lists the particular movements of cash a company will experience throughout its operational lifetime. Reviewing this statement can help owners and managers discover problems related to the company’s negative cash flow.
High operating expenses are one reason a company may have negative cash flow. Operating expenses are recorded in the operating section on the statement of cash flows. Companies that overpay for labor, raw materials, utilities, maintenance for facilities and other items needed to run the daily operations have a greater potential for negative cash flow.
Low sale volume also leads to negative cash flow. If a company cannot sell enough goods in the open market, than the company will certainly experience low cash flows. Poor cost accounting practices may be the reason for low sales and high operating costs. Companies that cannot account for and allocate costs to products effectively will not understand how to price products.
In the investing section of the statement of cash flows, investments into fixed assets can show problems relating to cash flows. Purchasing too many fixed assets that will not add value to the company will result in immediate cash flows with no potential for future cash inflows. This can be both an immediate negative cash flow situation and a long-term cash flow problem.
The investing section closely relates to the financing section of the statement of cash flows. Companies will often need outside financing to help pay for fixed assets. Engaging in loans that have high interest rates, balloon payments or other unfavorable terms will result in high cash payments for loans the company must pay prior to operating expenses.
One of our editors will review your suggestion and make changes if warranted. Note that depending on the number of suggestions we receive, this can take anywhere from a few hours to a few days. Thank you for helping to improve wiseGEEK!