By Devra Gartenstein Updated October 29, 2018
If your company has negative cash flow from operations, you may not be making any money. There are plenty of reasons why a company might have overall negative cash flow, such as making long term infrastructure investments. But if your cash flow specifically from operating activities is insufficient, then you either aren't earning sufficient amounts to cover your expenses or you aren't getting paid quickly enough. Either way, it's a good idea to look at both your business model and your payment terms.
What is Operating Cash Flow?
Operating cash flow describes the relationship between what your business spends and earns from day to day operating activities, or expenditures and revenue related to creating and providing your products and services. When you buy materials and pay employees to manufacture inventory, you incur operating expenses. When you take money from your customers, you generate operating income. If your business model is healthy, you'll receive more money than your spend and your operating cash flow will be positive. If you spend too much on materials and labor, or if your customers don't pay you quickly enough, your operating cash flow could be negative and you'll have to develop other strategies to pay your bills.
Using the Operating Cash Flow Formula
The operating cash flow formula tracks the changes in your earnings and assets relative to the income shown on your profit and loss statement. The formula reads as follows: Net income plus or minus changes in assets and liabilities, plus noncash expenses equals operating cash flow. The net income in this formula is the amount recorded on your income statement, which factors in some assets and liabilities using accounting conventions such as depreciation and amortization, which follow IRS guidelines but don't necessarily reflect the ways that cash is flowing in and out of your business. Because of this tenuous correlation, these deductions are referred to as "noncash expenses". Factoring in the changes in assets and liabilities, and then adding back the depreciation and amortization that you didn't actually spend during the current tax year brings the numbers on your income statement back into line with your actual, or operating cash flow.
Evaluating Your Business Model
Your business model is the way your company earns and spends money. To earn a net profit, you must earn more than you spend, at least in the long term. There will be times when your business makes investments in infrastructure. When you upgrade your equipment, you may spend more than you earn, but if your company is healthy and your investments are sound, these purchases will more than pay for themselves in added long-term earning potential. But equipment upgrades are occasional happenings and your company's regular operating expenses, such as rent, materials and payroll, shouldn't exceed the income you receive selling your goods and services. If you do earn more than you spend, your cash flow will be negative, unless you take out loans to cover the difference. However, if you do use financing to cover operating shortfalls, your borrowing will show up as changes in your assets and liabilities when you use the operating cash flow formula.
The Role of Accounts Receivable
The accounts receivable figure on your balance sheet represents the sums that you have earned but have not yet been paid. The operating cash flow formula adjusts for accounts receivable, because it is an asset that gets added back into your total, even though you don't yet have the money. But if your customers aren't paying you quickly enough, you could run into cash flow issues, even though you've actually earned enough to stay solvent. When evaluating cash flow issues, it's important to keep in mind the fact that you've done the work and it's just a matter of time until you get paid, while also recognizing that you may need more money in your bank account to actually cover your bills.
