Company and state cash flows

Company and state cash flows

There are periods where companies will keep operating with losses. Why would any company want to operate with a loss? Because management thinks that it will turn to profit at some point. Companies aim to have not only overall profits but also satisfactory return. That doesn’t mean that they will have profits in every single year. Most companies may want to keep operating during the coronavirus crisis because they think or hope that once things get better, they will have profits again that will make up for their losses.

Cash flow may be a problem that will prevent them from continuing operations although they want do. A company’s and an investment's valuation is based on cash flows. Of course, a company aims for profit but cash flow is the real thing. A company may even have a cash flow problem even if it makes profits. How would that be possible?

Suppose a company is making good profits for a long period. Management decides to make an investment and pays with all the profits accumulated. Obviously, they believe that the prospects are good, otherwise they wouldn’t go on with the investment. Now things may not turn out that good because of external reasons that they did not anticipate. If they get even slightly “in the red”, they may encounter some serious cash flow problems although they have been making big profits for a long time. This is only one example.

Profit-loss is different than cash flows for a variety of reasons. It was explained in co-entrepreneurship that new entrepreneurial efforts very often have losses for several months in the beginning but cash keeps flowing. If cash does not flow, the company can’t continue. Cash flows from shareholders’ capital. In addition to the initial investment, entrepreneurs should have more capital that will help them stay alive. Cash can be from loans as well although in the case of entrepreneurial endeavors, it is hard to find lenders during the first months of operation.

Another reason that differentiates cash flows from profit/loss is credit terms. Companies buy and sell on credit. The do not pay or get paid right away but after a while. Credit period may range from a month to six months. For a new company, it will be hard to get good credit terms from suppliers while established customers will require them. New companies need customers and will have to accept their terms, otherwise they will lose customers. A small part of the amount owed to them will never be paid although it was included in revenues and profit/loss.

Generally, all types of payments and receipts do not happen in the same period with revenues and expenses that determine profit/loss. Established companies have a cushion of cash and liquid assets. Liquid assets can be transformed to cash quickly. These have low returns and that is a reason for not wanting them to be a substantial amount. It lowers the overall return of the company.

When a company has cash problems, it will not shut down right away. There a few actions to take before. It could renegotiate credit terms with suppliers and customers. Finding other suppliers will not hurt much the business but losing customers will. Then it can start delaying payments, paying after the time agreed.

If shareholders have the ability, they increase their capital. Lenders or new investors may be another option. This will bring in cash. These will both be expensive. Either the interest rate will be high or the shares will be bought at a low price when a company has cash problems. Liquidating inventory and fixed assets is another option. This will be at a big discount and it might hurt the business.

Not only companies but countries have cashflows as well. Receipts and payments are closely related but different concepts than revenues and expenditures. Cash inputs and outputs may come from current, past or future periods. Borrowing is neither a revenue or an expenditure but is included in cash flows. Interest payments are expenditures but principal payments are not. Bankruptcy is a cash flow problem.

A couple of examples will make this clear. Taxes are paid in the following year. In addition to that, a government may have installments for taxpayers that are longer than a year. Tax revenue will not be paid in the year that incurred but in many years. Let’s assume that government borrows for some infrastructure project. When getting the loan, there will be a cash input but this is not revenue because it will have to be paid back. When paying installments in the years to come, it will consist a cash output. Except the interest part, it will not be an expenditure.

When a country has cashflow problems, it can increase taxes or decrease government investment and payroll expenditures. These measures will slow down the economy which will further decrease taxes and a recessionary cycle will start. Another alternative is to borrow more money. If the debt is high and the economy has problems it would be too expensive or impossible. A last resort is to print money. This is not possible for countries in EU because they cannot print their own money. Printing money will create inflation and cause other problems.

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