Negative cash flow occurs when a company’s cash outflow over a certain period of time is higher than its cash inflow. Cash outflow is a fancy way to say expenditures; it can apply to any operating costs, expansion expenses, investments and other costs to the company. Cash inflow is a fancy was to say profits; cash inflow is gross, meaning no expense has been subtracted from the profits. Negative cash flow at the end of a month or quarter can be a bad sign, but it is not necessarily a sign of financial weakness.

Initial Negative Cash Flow

When a company first opens its doors, negative cash flow is essential. Many businesses will spend three or more years without turning a profit in their infancy. This allows them to pour the resources needed into developing the brand through marketing and other efforts. Only after a company has a client base can the cash inflow start to outweigh the cash outflow. In fact, companies that turn a profit too early may show signs of severe cost cutting early on, which can compromise their relationship with employees and clients in the future. Expect some initial negative cash flow with a company during its opening years.

Temporary Negative Cash Flow

There are periods in a business’s ongoing operation when it will need to exhibit negative cash flow. Expansion is one of those times. If a company only relies on its initial business loans to drive growth in the future, it may be limiting the potential earnings of a market. Once a business is standing on its own two feet and earning a healthy profit, it should begin thinking about forward movement. Employees will need raises, stock holders want dividend growth, and these things only occur if a business expands through a short period of negative cash flow.

Seasonal businesses may also experience negative cash flow for a limited period of time. For example, retail clothing stores will have negative cash flow during slow periods when they are primarily purchasing merchandise. These companies are notorious for going through a whole year in the red before finally returning to a positive cash flow around the holiday season. Construction companies, school supply companies and other organizations that operate on a seasonal time table may have periods of negative cash flow prior to periods of highly positive cash flow.

Chronic Negative Cash Flow

Negative cash flow is a problem when it cannot be justified through an expansion. If a business has negative cash flow unexpectedly, this may be a sign of a more systemic problem. A business with constant negative cash flow is losing money over time. This loss can result in unpaid bills first. The next move a business will make in order to rectify the problem is a series of layoffs. Once you see a company taking these steps, you should be wary of its financial health in the future. Only if the company can show it rectifies the problem immediately through a direct action will it survive and begin to generate positive cash flow in the future.

$7 Online Trading. Fast executions. Only at Scottrade