Question

1. Why is it important that we sub-divide cash-flow into its three categories: operations, finance, and investing? If a company’s operating cash flow has been negative for several years, is that a good sign or bad sign? Explain.

Answer 1

The three subdivisions are the general cash inflows and outflows of the sources and application of funds. All these cashflows are categorised into three subdivisions.

For any company, the cash that has been generated through normal operations of the business is called as operating activities.

The investing activities are the cash that has been expended to build the assets to improve the revenue stream and profitability.

The financing activities are the cash that will come through either internal or external sources of funding these assets.

To have a clarity of these activities seperately, it is important to segegrate the cash flow statement into three categories.

Usually, if companies entered into business initially, the operating cashflows would be negative and these negative cashflows are offset by the positive financing activities. It takes some time for the companies to turn positive operating cashflow because initially the revenue will be less and companies have to incur the fixed costs. At the same company will have higher working capital requirements. All these facors pull the compay to have negative operating cashflows. But if companies continue the negative operating cashflows through several years that is a bad omen, means company is still not became self sufficient.