Question

In year 1, a company makes xxx sales and xxx expenses. The end result is negative net income. In year 2, the company's sales and expenses are the same and thus still have negative income.

In year 1, the company sold its assets and reduced some current liabilities, resulting in positive cash flow in operating activities. Investing activities were marginally positive with an increase in ppe. Cash flow from financing activities was negative and the overall balance sheet changes as negative. In year 2, the company saw negative cash flows in operating and investing activities, but a positive cash flow in financing activities. The overall balance sheet changes were positive due to a substantial increase in finance activities.

Compared to year 1, how is the health of the company in Year 2?

Answer 1

First of all it should be understood that what are cash flow from operating activites, cash flow from investing activities and cahs flow from financing activities.

Cash flow from operating activities include cash flows that arise from day to day activities of the business like sale of product or service leads cash inflow, payment of wages, payment of interest, other day to day expenses lead to cash outflow. The difference between sales and expenses generate income. If sales are more than expenses it means positive income and if expenses are more than sales then it is negative income or loss.

Cash flow from investing activities include purchase or sale of property , plant and equipment ; purchase or sale of marketable securities. Purchasing of the ppe and marketable securities involve cash outflow. sale of ppe and marketable seucirties involve cash inflow.

Cash flow from financing activities involves include issue or repurchase of stock; issue or redemption of debt or getting or paying long term debt. If finance is raised through issue of stock, bonds, raising long term loans etc. it results into cash outflow and repurchase of stock, redemption of debt and repayment of long term loan results into cash outflow.

Now in the present case in the year 1 and Year 2 operating activities have resulted into negative income meaning thereby that expenses are more than sales. In the year 1 company sold some assets to pay current liabilities and resulting in positive cash flow which means there was net increase in current assets. In the same year, there was purchase of property, plant and equipment. It can be seen as a healthy sign because investing in property plant and equipment may lead to more earnings in the future period through utilization of ppe. However it is also noticeable that investing activities have increased marginally which indicates marketable securities may have been sold. Now in the year 1, cash flow from financing activities was also negative which shows repayment of debt or loan or repurchase of stock.

Comparing to year 1 , again in the year 2 cash flow from operating activites is negative due to more expenses than sales. Also year 2 showed negative cash flow in investing activities which points toward purchase of ppe or marketable securities. On the other hand cash flow from financing activities has positive which indicates either raising debt or issue of stock. Now comparing both years activites it can be said that health of the company in year 2 improved as compared to year 1. The for this being company has raised loan/borrowings etc. in the year 2 to make purchase of ppe and/or marketable securities. Assuming that if borrowing from financing acitivies has been used to make investment in ppe it is considered as good sign because it points towards the expectation that company will be growing in future years. Negative cash flow in investing activities is a sign of growing for which company is investments in assets. However it should also be noted that assets be used properly so that profits can be generated and returns to sources of finance is ensured.