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Originally Posted by tobywood I am trying to understand how operating activities can be a net use of cash when a company is operating profitably? 
Also, if a company has cash and equivalents of $80K in 2004 and $37K in 2006, and management is forcasting that operating activities will be an even greater use of cash in 2006 will the company be heading toward illiquidity? I believe the answer to be yes as the company will have exhausted all available liquid cash. Is this correct? 
Additional information: Management feels that sales with triple each year for the next 5 years. I think that this information changes my original thought. With a tripling in sales, the company should be able to meet their liability obligations which means they should be able to maintain liquidity if the appropriate cash flow management processes are put in place. |
It is very common for a growing company to show great profitability but to be in a negative cash flow position. A company that is growing rapidly will need to make a lot more inventory (or purchase inventory), (a cash use), their receivables will go up quite dramatically because their sales are increasing, (a cash use) - very typical
If a company is forecasting that operating activities will be even greater use of cash, the company will be having cash flow and liquidity issues, I am not sure that I would say it is going to be illiquid. A company that is growing but having cash flow issues can usually borrow money or sell equity
If a company's sales are going to triple each year for the next 5 years, they have some major cash flow issues, see the first point above, they will have to finance a lot more inventory in advance of selling the product and they will have to wait to collect money from their receivables.
Hope this helps, Herman
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