How to Evaluate Companies With Negative Cash Flow Investments (2024)

Understanding why a company has a negative cash flow from investing activities can be a challenge. It could be a warning sign that the company's management is not efficiently using its assets to generate revenue. But it might also be a positive sign that management is positioning the company for future growth.

You can tell which it is by taking a close look at the company's cash flow statement.

Key Takeaways

  • If a company has a negative cash flow from investing activities, it will appear on the cash from investing activities section of their cash flow statement.
  • The cash flow statement indicates how well a company's management generates cash to pay its debts and fund its operating expenses.
  • A company might have a negative cash flow from investing activities because management is investing in long-term assets that should help its future growth.
  • To decide if a company's negative cash flow from investing activities is a positive or negative sign, investors should review the entire cash flow statement.

The Cash Flow Statement

Cash flow from investing activitiesis one of the threesections that make up a company's statement of cash flows. This part of its financial report summarizes the amount ofcash and cash equivalents(CCE) entering and leaving a company during a stated period.

The cash flow statement complementsthebalance sheetandincome statement.

The cash flow statement (CFS)reports how the company uses the money it takes in from its operations. The main components of the cash flow statement are:

  • Cash from operating activities
  • Cash from investing activities
  • Cash from financing activities

Cash From Investing Activities

The investing activities section includes any outflows of cash or sources of cash from a company's investments. A purchase or sale of an asset, cash out due to a merger or acquisition, loans made, or loan proceeds received are all included.

In short, any changes in assets, investments, or equipment will be accounted for in investing activities. When a company divests an asset, the transaction is considered a credit or "cash in" and is listed in investing activities.

Interpreting Negative Cash Flow

Companies and investors naturally like to see positive cash flow from all of a company's operations, but having negative cash flow from investing activities is not always bad. To make an evaluation of a company's investing activities, investors need to review the company's particular situation in greater detail.

It's not uncommon for a growing company to have a negative cash flow from investing activities. For example, if a growing company decides to invest in long-term fixed assets, it will appear as a decrease in cash withinthat company's cash flow from investing activities.

Even well-established companies makeinvestments in long-term assets such as property and equipment from timeto time. This might cause investing activities to go negative for the period.

Real World Example of Negative Cash Flow Investments

For example, below is the cash flow statement from Exxon Mobil (XOM). Here are some important points to consider:

  • We can see that net cash used in investing activities was-$1.859 billion for the period (highlighted in green).
  • Thetwo primary drivers for the negative investing activities number were the purchase of property, plant, and equipment (PP&E) for$3.349 billion and the sale of assetscrediting cash for $1.441 billion.
  • However, cash from operating activities (in blue)totaled $8.519 billion and is more than enough cash to pay for the investment in fixed assets.

How to Evaluate Companies With Negative Cash Flow Investments (1)

What the Numbers Mean

In this example, an investor might be concerned about negative cash flow in investing activities to the tune of $1.8 billion.

However, when we delve into the numbers, we can see it's a positive sign.Exxon Mobil is an oil and gas producer. It needsto update its equipment like drilling rigs, and it needs to purchase equipment periodically. As a result, the negative cash flow from investing meansthe company is investing in its future growth.

If a company has a negative cash flow from investing activities because it hasmade poor decisions, the negative cash flow from investing activities might be a warning sign.

What Does a Cash Flow Statement Reveal?

A company's cash flow statement can reveal what phase the business is in. Is it an early startup, eager to grow its business quickly? Its cash flow statement may reveal that it's purchasing the facilities or equipment that it needs to ramp up. Is it a mature business? It may be developing new lines of business or acquiring rivals. If the business isn't doing much but treading water, that may be revealed by the cash flow statement as well.

How Is Cash Flow from Operating Activities Calculated?

There are two methods of calculating cash flow from operating activities:

The direct method: Take the sum of all cash collections from operations and subtract all of the cash disbursem*nts from operations.

The indirect method: Start with total net income and adjust it to subtract the impact of the accruals made during the reporting period, such as depreciation and amortization.

Either method will result in the same number.

Both of these methods comply with Generally Accepted Accounting Principles (GAAP).

Can a Company Be Profitable and Have Negative Cash Flow?

Yes, a profitable company can have negative cash flow. Negative cash flow is not necessarily a bad thing, as long as it's not chronic or long-term. A single quarter of negative cash flow may mean an unusual expense or a delay in receipts for that period. Or, it could mean an investment in the company's future growth.

It's up to the investor to decide whether the investments listed under "cash flow investments" are worthy uses of the company's cash.

The Bottom Line

It's important to analyze the entire cash flow statement and all itscomponents to determine if the negative cash flow is a positiveor negative sign.

The most effective way to evaluate a negative cash flow situationis to calculatea company's free cash flow. Free cash flow is the money the company has left after paying for capital expenditures (CapEx) and operating expenses.

This is an important metric for investors because it shows how effective a company's management is at generating cash.

How to Evaluate Companies With Negative Cash Flow Investments (2024)

FAQs

How to Evaluate Companies With Negative Cash Flow Investments? ›

The most effective way to evaluate a negative cash flow situation is to calculate a company's free cash flow. Free cash flow is the money the company has left after paying for capital expenditures (CapEx) and operating expenses.

Could a firm with negative free cash flow still be highly valued by investors? ›

Would it be possible for a company to report negative free cash flow and still be highly valued by investors; that is, could a negative free cash flow ever be viewed optimistically by investors? Explain your answer. Yes. Negative free cash flow is not necessarily bad.

What should a business do if it has a negative cash flow? ›

Negative cash flow isn't necessarily a bad thing if you're following a plan. However, you want to avoid running out of cash entirely. To avoid this situation or simply to improve your business cash flow, you may want to consider exploring available business funding sources.

How do you evaluate a company's cash flow statement? ›

One can conduct a basic cash flow analysis by examining the cash flow statement, determining whether there is net negative or positive cash flow, pinpointing how the outflows compare to inflows, and draw conclusions from that.

What is the best interpretation of a firm's negative cash flow? ›

Negative cash flow is often indicative of a company's poor performance. However, negative cash flow from investing activities might be due to significant amounts of cash being invested in the long-term health of the company, such as research and development.

Can a company be profitable with negative cash flow? ›

A business could make net profit while having negative cash flow. Earning revenue does not necessarily mean that the company has received cash immediately. The actual movement of cash may happen later. For instance, a company sold goods and accrued profit on the income statement but did not receive the money yet.

How do you value a company with no cash flow? ›

Asset Based

The value of a company with no future projected cash flow -- but one that does have assets -- would be based on a discounted value of the assets less liabilities. Cash, bonds and stocks are counted at face value. Real estate would be at market value, not the depreciated value.

How do you finance negative cash flow? ›

How to fix negative cash flow
  1. Create a cash flow statement. You won't be able to manage your finances without accurate, up-to-date financial statements. ...
  2. Review and reduce outgoing expenses. ...
  3. Find access to back-up cash. ...
  4. Automate y createsour accounting processes. ...
  5. Streamline your payments process.

In which stages would you typically expect to see large negative investment cash flows? ›

During the startup phase of a business, it is normal to see negative operating cash flows, negative investing cash flows and positive financing cash flows. The startup will be obtaining financing cash to start the business and will be using these funds to make investments for the future of the business.

What do investors look for in a cash flow statement? ›

The CFS measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses. As one of the three main financial statements, the CFS complements the balance sheet and the income statement.

What do investors analyze the cash flow statement to determine? ›

Analysis of cash flow statements can help business owners and investors understand a company's cash position and liquidity, identify potential cash flow problems, and make informed financial decisions.

What should a company do to ensure cash flow statements are accurate? ›

In this article, you will learn some tips and best practices to ensure cash flow statement accuracy and avoid common mistakes.
  1. 1 Review your income statement and balance sheet. ...
  2. 2 Categorize your cash flows correctly. ...
  3. 3 Use the indirect method for operating cash flows. ...
  4. 4 Reconcile your cash flows with your bank statements.
Sep 14, 2023

What does a negative investing cash flow mean? ›

Negative investing cash flow occurs when a company spends more cash on its investing activities than it receives from them. This means that the company is using its cash to buy or improve its fixed assets, such as buildings, machinery, or technology.

Can a company report negative free cash flow and still be highly valued by investors that is could a negative free cash flow ever be viewed optimistically by investors? ›

Yes, a profitable company can have negative cash flow.

How do you value a company with negative FCF? ›

Another method for valuing a start-up or a high-growth company with negative or uncertain cash flows is the relative valuation method, which compares the company to similar or comparable companies in the same industry or market, and uses multiples or ratios to measure the value.

What does it mean when a firm's free cash flow is negative? ›

Free cash flow is arguably the most important financial indicator of a company's stock value. A positive FCFF value indicates that the firm has cash remaining after expenses. A negative value indicates that the firm has not generated enough revenue to cover its costs and investment activities.

Is free cash flow important to investors? ›

Free cash flow (FCF) is a company's available cash repaid to creditors and as dividends and interest to investors. Management and investors use free cash flow as a measure of a company's financial health. FCF reconciles net income by adjusting for non-cash expenses, changes in working capital, and capital expenditures.

Top Articles
Latest Posts
Article information

Author: Prof. Nancy Dach

Last Updated:

Views: 6259

Rating: 4.7 / 5 (77 voted)

Reviews: 84% of readers found this page helpful

Author information

Name: Prof. Nancy Dach

Birthday: 1993-08-23

Address: 569 Waelchi Ports, South Blainebury, LA 11589

Phone: +9958996486049

Job: Sales Manager

Hobby: Web surfing, Scuba diving, Mountaineering, Writing, Sailing, Dance, Blacksmithing

Introduction: My name is Prof. Nancy Dach, I am a lively, joyous, courageous, lovely, tender, charming, open person who loves writing and wants to share my knowledge and understanding with you.