You are considering an investment in a new start-up company, Over Armour, Inc., an Internet service...

You are considering an investment in a new start-up company, Over Armour, Inc., an Internet service provider. A review of the company's financial statements reveals a negative retained earnings. In addition, it appears as though the company has been running a negative cash flow from operating activities since the company's inception.

How is the company staying in business under these circumstances? Could this be a good investment?

Why or why not?

Expert Solution

As mentioned, the Company is in start up phase.

Negative retained earnings means that the company is yet to achieve its breakeven. This is also causing a negative cash flow from operating activities (which reflects negative working capital cash flow).

In such a situation where there is negative earnings and negative working capital cash flow , the Company is staying in business with its long term funds or debts which it might have raised for the purpose of investing in business.

This is a normal scenario in case of start-ups. Once the break-even point is achieved, the company would be able to recover its operational costs thus resulting in positive profits & retained earnings and also positive working capital.

Investment in this start-up business can be considered since it is engaged in internet service providing facilities which is in great demand in the modern era. Also, start-ups tend to be managed by young enthusiastic entreprenuers who bring about new and innovative business ideas thus resulting in rapid growth of the business in a shorter span of time as compared to traditional companies.

However, due diligence is required to exercised before making the investment. Some of the factors which can be looked into are as under:

1. Whether the Business Model is strong enough to sustain the highly competitive market place;

2. What are the other investment options available

3. The technical and economic feasibility of the project

4. What is the gestation period and when would the company be able to achieve its break-even

With prudent analysis, a wise investment decision can be taken.

ekkarill92 answered 2 years ago

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