Question

Explain why a company in the introductory stage of its life cycle is a net user of cash. Use specific items from the balance sheet and cash flow statement in your explanation.

Answer 1

Cash generation is possible only with sales.

Sales are possible with investment in Inventory, Wages and salaries, and other operating expenses.

Inventory production is possible only with the use of property, plant and equipment.

Increase inventory, accounts receivable, and accounts payable are part of working capital.

Excess of current assets such as accounts receivable, inventory over current liabilities (accounts payable) is working capital.

Investment maily required in property, plant, and equipment at the beginning of project. Investment in inventory increases working capital requirement which is another reason for cash outlay.

These amounts are huge and will generate cash over their useful life.

Because of the need for investment in property, plant and equipment and working capital requirements, a company is cash user in introductory state.

Cash use in property, plant and equipment is cash used in investment activities.

Cash used in working capital is cash used in operating activities.

Cash for both requirements is financed through either debt or equity which is part of cash from financing activities section of the cash flow statement.

Hope above explanation helps.

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