What is the indication of positive net cash flow from investing activities?

The net balance of cash moving in and out of a firm at a certain time is referred to as cash flow. The cash flow from investing can either be negative or positive. Positive cash flow shows that a corporation is bringing in more money than spending. Negative cash flow infers the expenses outweigh the income.

What is cash flow from investing activities?

Cash flows from investing activities highlight how much money was spent on non-current assets (also known as long-term assets) that will offer value in the future. Investing is a vital part of capital and growth. Investment activity changes property, plant, and equipment (PPE), a major line item on the balance sheet. Investors and analysts can determine how much a firm spends on PPE by looking at the sources and utilisation of funds in the cash flow statement’s investing section.

Capital expenditures (CapEx), a typical indicator of capital investment used in stock valuation, is also featured in this section. A rise in capital expenditures indicates that the corporation is putting money into future operations. On the other hand, capital expenditures are a drain on cash flow. Typically, businesses that spend substantial money on capital are expanding.

Purchasing fixed assets is an example of cash flow from investing activities with a negative cash flow. Likewise, collecting loans and insurance proceeds is a positive cash flow from investing activities.

Why is cash flow from investing activities important?

Investing activities involve the purchase or sale of long-term assets. The purchase of a business car, selling a building, or acquiring marketable securities are all examples of this. These items are recorded in the investment section of the cash flow statement because they entail the long-term usage of capital.

Capital flow from investment activities is significant because it demonstrates how a firm allocates cash over time. For example, to expand a firm, a company can invest in fixed assets such as property, plant, and equipment. While this indicates a short-term negative cash flow from investment operations, it will help the organisation produce cash flow in the long run. A corporation can invest capital in short-term marketable securities to enhance profits.

Although a company’s investment operations may generate negative cash flow, this does not always imply hurting the firm. The company’s cash flow might be impacted by purchasing property, plant, and equipment, but these assets will help produce revenue growth in the long run.

How to calculate cash flow from investing activities?

If you use accounting software to monitor and record your financial activities, calculating cash flow from investment activities is done automatically. If you do not have an automated system, you can use the following formula. 

Cash flow from investing activities = Total Investment Sum + Gains – Sale value 

These totals will subsequently be recorded on a cash flow statement for your business. Cash flow from investing activities is a segment of the cash flow statement showing the cash inflows and outflows from investing activities in an accounting year. Investing activities include cash flows from the sale of fixed assets, the purchase of fixed assets, and the sale and purchase of business investments in shares or properties, among other things.

All cash transactions―cash in (receipts) and cash out (disbursements)―fall into three categories: operations, investing and financing.

• • 1. Operations: Cash flows from operations. This refers to the net cash received in the form of revenue from sales or service, less cash spent on expenses of running the business.
    2. Investing: Cash flows from investing. This refers to cash spent on items to be used over multiple years to increase efficiency or profitability for the business (e.g., equipment, technology and investments in business relationships or joint ventures). Negative cash flows are investments in, or purchases of, these assets. Positive cash flows are divestments of, or sale of, these assets.
    3. Financing: Cash flows from financing. This refers to money received as debt or equity (e.g., bank loans, capital contributions from shareholders). Incurring debt and receiving contributions are shown as positive transactions. Paying off debts and paying shareholders are shown as negative transactions.

Startups and cash flow

During the startup phase of a business, it is normal to see negative operating cash flows, negative investing cash flows and positive financing cash flows. The startup will be obtaining financing cash to start the business and will be using these funds to make investments for the future of the business. There likely will be a few years of operating losses resulting in negative cash flows while the company has expenses but little revenue.

Growth-stage companies and cash flow

At the growth stage, it is normal to see positive operating cash flows, negative investing cash flows and neutral financing cash flows. The company will start generating some income and will use the resulting cash to continue investing in assets for the future of the company. These investments will likely be to a lesser extent than during the startup phase, as many earlier investments should still be used and beneficial to the company. Financing will likely be neutral as the company will require fewer injections of cash to stay afloat now that it is generating cash from operations. However, the company will likely not be repaying substantial amounts as it should be using this money to reinvest in the business.

Later-stage companies and cash flow

In later-stage companies, it is normal to see positive operating cash flows, neutral investing cash flows and negative financing cash flows. Cash generated from profitable operations can be used to repay debt and pay dividends to shareholders.

Cash flow statement

The cash flow statement in the financial statements will show net cash transactions in each category for that specific time period, which is helpful for business owners to track trends to ensure the company is moving from a startup phase to a growth-stage or later-stage company.

Allocating limited cash: Interest, penalties and borrowing covenants

Often a company faces multiple demands for its cash but has only a limited amount. There are three key considerations when deciding where to allocate the cash:

• • 1. Interest rate: Pay off the liabilities with the highest interest rates first. This sounds intuitive, but when multiple claims are being requested (with some more vocal than others), this can be overlooked. Take advantage of interest-free periods, as some suppliers may give terms of payment (30, 45 or 60 days) that are interest-free.  If this is the case, make other payments first.
  • 1. Penalties for late payments: Where penalties for late payments are steep, it is crucial to pay these before the penalties are assessed.
  • 1. Borrowing covenants: When obtaining financing (e.g., bank loans), the lender may require that certain conditions (such as liquidity) be met at all times. If these covenants are broken, the lender may have the right to demand full repayment. This will mean the debt has to be classified as short-term on your balance sheet and this can negatively affect on your liquidity ratios, which may cause further breaches and problems from investors and lenders. The combined effect can cripple a business at the worst time. 

Avert the worst scenario first

When allocating limited cash, if all three of the above scenarios are being considered, the worst must be averted first. This usually (but not always) means preventing broken covenants, then preventing penalties and then paying off debt with the highest interest rate. The possibility exists that if the situation is discussed with the lender, they may allow the company to break a covenant and forgo their right to collect the principal for a short period. Make sure this is approved first, but if it is, penalties and high-interest rate liabilities become the priorities.