Question

Suppose you are the only owner of a chain of coffee shops near universities. Your current cafés are doing well, but you are interested in starting a fine-dining restaurant. You decide to use the cash generated from your existing business to enter into a new business. Your accountant provides you with the following data on your current financial performance:

Financial update as of June 15

•	Your existing business generates $87,000 in EBIT.
•	The corporate tax rate applicable to your business is 25%.
•	The depreciation expense reported in the financial statements is $16,571.
•	You don’t need to spend any money for new equipment in your existing cafés; however, you do need $13,050 of additional cash.
•	You also need to purchase $6,960 in additional supplies—such as tableclothes and napkins, and more formal tableware—on credit.
•	It is also estimated that your accruals, including taxes and wages payable, will increase by $4,350.

Based on your evaluation you have   in free cash flow.

Can a company have negative free cash flow?

Yes

No

Answer 1

Yes , a company can have a negative free cash flow if it does not generate enough cash to support it's expenses.

Explanation:

In the case above, the business generates $87,000 before interests and taxes, the tax applicable is 25% which means that the business income after tax is $65,250. It incurs a depreciation expense of $16,571 and an additional expense of $13,050. Additional supplies will cost $6960 plus an increase in the accruals by $4,350. This brings the total operating expense by the company to $40,931. Given that the business generates a cash flow of $65,250 after tax, then this means it will have a positive free cash flow of $24,319.

If the business had not generated enough cash flow to meet it's operating expenses, then it would have a negative free cash flow.