EBK PRINCIPLES OF MANAGERIAL FINANCE
EBK PRINCIPLES OF MANAGERIAL FINANCE
14th Edition
ISBN: 9780100666757
Author: ZUTTER
Publisher: YUZU
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Textbook Question
Chapter 4, Problem 1OR

Opener-in-Review

The chapter opener described a company that reported increases in revenues and profits, but even so, the company’s free cash flow was negative. Explain why a profitable, expanding business may have negative free cash flow.

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Summary Introduction

To discuss: Reason for why a profitable growing business may have a negative free cash flow.

Introduction:

Cash flow is the inflow and outflow of cash and capital in a business where, a positive cash flow implies rise in the liquid assets, return on capital to the shareholders and more whereas a negative cash flow includes decreasing in the firm’s liquid assets.

The free cash flow indicates whether the company has adequate cash flow to cover both the operating as well as the fixed and current assets investments.

Explanation of Solution

The free cash flow (FCF) indicates whether the company has adequate cash flow to cover both the operating as well as the fixed and current assets investments as it represents the cash available to investors, creditors or equity owners after all these needs are met.

A firm may have to make additional investments in inventory, fixed assets, receivables etc. when it is expanding and such investments may not be necessarily show up immediatley in the profit calculation eventhough they reduce free cash flow.

When a company needs to make important investment into fixed or working capital higher than operating cash flow; then the firm may be generating high revenue and profit but may not be sufficient to pay creditors or owners. Thus the negative free cash flow may occur when the business is in an expansion phase where high investments is required in fixed asset and current assets to meet the growth requirements.

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EBK PRINCIPLES OF MANAGERIAL FINANCE

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