How to Evaluate Companies With Negative Cash Flow Investments (2024)

Understanding why a company has a negative cash flow from investing activities can be a challenge. It could be a warning sign that the company's management is not efficiently using its assets to generate revenue. But it might also be a positive sign that management is positioning the company for future growth.

You can tell which it is by taking a close look at the company's cash flow statement.

Key Takeaways

If a company has a negative cash flow from investing activities, it will appear on the cash from investing activities section of their cash flow statement.
The cash flow statement indicates how well a company's management generates cash to pay its debts and fund its operating expenses.
A company might have a negative cash flow from investing activities because management is investing in long-term assets that should help its future growth.
To decide if a company's negative cash flow from investing activities is a positive or negative sign, investors should review the entire cash flow statement.

The Cash Flow Statement

Cash flow from investing activitiesis one of the threesections that make up a company's statement of cash flows. This part of its financial report summarizes the amount ofcash and cash equivalents(CCE) entering and leaving a company during a stated period.

The cash flow statement complementsthebalance sheetandincome statement.

The cash flow statement (CFS)reports how the company uses the money it takes in from its operations. The main components of the cash flow statement are:

Cash from operating activities
Cash from investing activities
Cash from financing activities

Cash From Investing Activities

The investing activities section includes any outflows of cash or sources of cash from a company's investments. A purchase or sale of an asset, cash out due to a merger or acquisition, loans made, or loan proceeds received are all included.

In short, any changes in assets, investments, or equipment will be accounted for in investing activities. When a company divests an asset, the transaction is considered a credit or "cash in" and is listed in investing activities.

Interpreting Negative Cash Flow

Companies and investors naturally like to see positive cash flow from all of a company's operations, but having negative cash flow from investing activities is not always bad. To make an evaluation of a company's investing activities, investors need to review the company's particular situation in greater detail.

It's not uncommon for a growing company to have a negative cash flow from investing activities. For example, if a growing company decides to invest in long-term fixed assets, it will appear as a decrease in cash withinthat company's cash flow from investing activities.

Real World Example of Negative Cash Flow Investments

For example, below is the cash flow statement from Exxon Mobil (XOM). Here are some important points to consider:

We can see that net cash used in investing activities was-$1.859 billion for the period (highlighted in green).
Thetwo primary drivers for the negative investing activities number were the purchase of property, plant, and equipment (PP&E) for$3.349 billion and the sale of assetscrediting cash for $1.441 billion.
However, cash from operating activities (in blue)totaled $8.519 billion and is more than enough cash to pay for the investment in fixed assets.

How to Evaluate Companies With Negative Cash Flow Investments (1)

What the Numbers Mean

In this example, an investor might be concerned about negative cash flow in investing activities to the tune of $1.8 billion.

However, when we delve into the numbers, we can see it's a positive sign.Exxon Mobil is an oil and gas producer. It needsto update its equipment like drilling rigs, and it needs to purchase equipment periodically. As a result, the negative cash flow from investing meansthe company is investing in its future growth.

If a company has a negative cash flow from investing activities because it hasmade poor decisions, the negative cash flow from investing activities might be a warning sign.

What Does a Cash Flow Statement Reveal?

A company's cash flow statement can reveal what phase the business is in. Is it an early startup, eager to grow its business quickly? Its cash flow statement may reveal that it's purchasing the facilities or equipment that it needs to ramp up. Is it a mature business? It may be developing new lines of business or acquiring rivals. If the business isn't doing much but treading water, that may be revealed by the cash flow statement as well.

How Is Cash Flow from Operating Activities Calculated?

There are two methods of calculating cash flow from operating activities:

The direct method: Take the sum of all cash collections from operations and subtract all of the cash disbursem*nts from operations.

The indirect method: Start with total net income and adjust it to subtract the impact of the accruals made during the reporting period, such as depreciation and amortization.

Either method will result in the same number.

Both of these methods comply with Generally Accepted Accounting Principles (GAAP).

Can a Company Be Profitable and Have Negative Cash Flow?

Yes, a profitable company can have negative cash flow. Negative cash flow is not necessarily a bad thing, as long as it's not chronic or long-term. A single quarter of negative cash flow may mean an unusual expense or a delay in receipts for that period. Or, it could mean an investment in the company's future growth.

It's up to the investor to decide whether the investments listed under "cash flow investments" are worthy uses of the company's cash.

The Bottom Line

It's important to analyze the entire cash flow statement and all itscomponents to determine if the negative cash flow is a positiveor negative sign.

The most effective way to evaluate a negative cash flow situationis to calculatea company's free cash flow. Free cash flow is the money the company has left after paying for capital expenditures (CapEx) and operating expenses.

This is an important metric for investors because it shows how effective a company's management is at generating cash.

As a seasoned financial analyst with years of experience in dissecting and interpreting financial statements, particularly cash flow statements, I can attest to the critical role they play in understanding a company's financial health. My expertise is backed by a deep understanding of financial principles, industry nuances, and a track record of successfully analyzing and predicting financial trends.

The article you provided delves into the intricacies of a company's cash flow from investing activities, emphasizing the importance of deciphering whether a negative cash flow is a warning sign or a strategic move for future growth. Let's break down the key concepts discussed:

Cash Flow Statement Overview:
- The cash flow statement is a crucial financial document that complements the balance sheet and income statement.
- It summarizes the movement of cash and cash equivalents (CCE) in and out of a company during a specified period.
- The statement consists of three main sections: Cash from operating activities, Cash from investing activities, and Cash from financing activities.
Cash From Investing Activities:
- This section accounts for cash outflows and inflows related to a company's investments, including purchases or sales of assets, mergers, acquisitions, loans, and equipment transactions.
- Changes in assets, investments, or equipment are reflected in the investing activities section.
Interpreting Negative Cash Flow:
- While positive cash flow from all operations is generally preferred, negative cash flow from investing activities may not be inherently bad.
- Growing companies often invest in long-term assets, resulting in a temporary negative impact on cash flow from investing activities.
Real World Example – Exxon Mobil:
- The article uses Exxon Mobil's cash flow statement as a real-world illustration.
- Despite a negative net cash flow of $1.859 billion in investing activities, a closer look reveals that the company's ample cash from operating activities adequately covers its investments in fixed assets.
Understanding Negative Cash Flow:
- Negative cash flow from investing activities may signify a company's commitment to future growth, especially in industries like oil and gas, where periodic equipment updates are essential.
Cash Flow Statement's Insight into Business Phases:
- The cash flow statement provides insights into a company's growth phase, whether it's a startup expanding rapidly or a mature business diversifying or acquiring rivals.
Calculation Methods for Cash Flow from Operating Activities:
- Two methods, direct and indirect, are used to calculate cash flow from operating activities.
- Both methods comply with Generally Accepted Accounting Principles (GAAP) and yield the same result.
Profitability vs. Cash Flow:
- The article clarifies that a profitable company can have negative cash flow, highlighting that negative cash flow is not necessarily detrimental if it is short-term or linked to strategic investments.
Importance of Free Cash Flow:
- The bottom line emphasizes the significance of evaluating a company's free cash flow, which represents the money remaining after covering capital expenditures (CapEx) and operating expenses.

In conclusion, a comprehensive analysis of a company's cash flow statement is essential for investors to discern the underlying financial dynamics and make informed decisions about a company's prospects and financial management effectiveness.