By Chron Contributor Updated September 21, 2020
Small businesses may have losses in the first year or two of operations because it takes time to establish a market presence and generate enough revenues to cover costs. A loss does not necessarily mean an example of negative cash flow, just as a profit does not always mean a positive cash flow. This is due to accrual accounting rules, which require companies to record transactions in the period they occur, not when they receive or pay cash.
Definitions and Basics
Net income is sales minus expenses, which include cost of goods sold, general and administrative expenses, interest and taxes. The net income becomes negative, meaning it is a loss, when expenses exceed sales, according to Investing Answers. Total cash flow is the sum of operating, investing and financing cash flows. Operating cash flow is usually different from net income because of adjustments for non-cash transactions. Investing cash flow usually consists of fixed asset transactions, such as the acquisition or sale of a manufacturing facility. Financing cash flow involves proceeds from sale or purchase of equity and debt securities.
Example 1: Depreciation
Depreciation is the periodic allocation of a fixed asset's costs over its useful life, which is substantially longer than a year. A common depreciation method is the straight-line method, in which the annual depreciation expense is the same each year. The depreciation accounting entries are to debit depreciation expense and credit accumulated depreciation, which reduces the book value of fixed assets on the balance sheet.
For example, if a small business has a $5,000 computer on its books, the annual depreciation expense over its estimated five-year useful life is $5,000 divided by 5, or $1,000. This expense will reduce net income, but it will be added back to operating cash flow because it is a non-cash expense. Therefore, while net income could be negative, the cash flow would show a gain.
Example 2: Accrued Expenses
Accrued expenses are expenses that have been recorded but have not been paid, such as salaries and interest expenses. For example, if a company makes direct deposits on day 15 of each month, it would have about two weeks' worth of wages accrued but unpaid at the end of the year. If this amount is $5,000, the accounting entries are to debit wages expense and credit wages payable by $5,000 each. This would reduce net income for the current year, possibly turning it negative, but the cash flow may still be positive because the wages payable amount is added back to the current year's operating cash flow, according to Accounting Coach.
Other Considerations
A negative net income could mean a lower tax expense this year and the possibility of applying the loss to reduce taxes in subsequent years. However, losses may not result in positive cash flows every year, because these losses may be too high for them to be offset by non-cash adjustments. Companies with negative cash flow do exist; examples of negative cash flow are usually geared around companies who are investing in research and development or other future endeavors.
Debits increase asset and expense accounts, and decrease revenue, liability and shareholders' equity accounts. Credits decrease asset and expense accounts, and increase revenue, liability and shareholders' equity accounts.
FAQs
Small businesses may have losses in the first year or two of operations because it takes time to establish a market presence and generate enough revenues to cover costs.
What is an example of positive net income and negative cash flow from operations? ›
It's possible to have a positive net income but have a negative cash flow. This can happen if you use the accrual accounting method and sell your products or services on credit. For example, say you have sales of $100,000 during January and expenses of $75,000. Your net income for the month is $25,000.
What is an example of a negative revenue? ›
A negative revenue figure may mean that you had to credit a customer or customers for more than you sold in a given period. Example: In January, you recorded $10,000 in revenue (this would show up as a positive figure, as it should). In February, you bill $4,000 in services to Client B.
What happens if net income is negative? ›
Negative net income means the company has incurred more expenses than its revenue, resulting in a loss. A negative net income can indicate that the company is struggling financially and may be unable to cover its obligations.
Can a company be profitable with negative net income? ›
A company with negative net income but positive cash flow can still be in a healthy financial position, especially if the positive cash flow is sustainable and supports operational needs and growth investments.
Do most businesses lose money the first year? ›
Most businesses don't make any profit in their first year of business, according to Forbes. In fact, most new businesses need 18 to 24 months to reach profitability. And then there's the reality that 25 percent of new businesses fail in their first year, according to the Small Business Administration.
Can a company have negative net income and positive cash flow? ›
It is possible for a company to have positive cash flow while reporting negative net income. If net income is positive, the company is liquid and profitable. If a company has positive cash flow, it means the company's liquid assets are increasing.
What is an example of a company with a negative cash flow? ›
Negative Cash Flow Examples. You won't be surprised to see big company names when speaking of negative cash flow. Netflix and Amazon are 2 of them. Although their cash flow statement may give negative implications, upon deeper analysis, we learn the situation is otherwise.
What is an example of a negative cash flow statement? ›
Negative cash flow is when your business has more outgoing than incoming money. You cannot cover your expenses from sales alone. Instead, you need money from investments and financing to make up the difference. For example, if you had $5,000 in revenue and $10,000 in expenses in April, you had negative cash flow.
Is it possible to have negative revenue? ›
If revenue is negative, the company may have lost money during operations or the tag may be incorrect. This issue tends to surface when someone is doing a massive dive into the data – looking at thousands of companies at a time without consideration of the industry the company is in.
The revenues are reported with their natural sign as a negative, which indicates a credit. Expenses are reported with their natural sign as unsigned (positive), which indicates a debit. This is routine accounting procedure.
Can you earn negative revenue? ›
In some rare cases, companies do report negative revenue. A negative value may be related to a change in accounting principles.. The accounting change alters the way the company places a value on money or assets. Despite changes in the books, the negative value may not represent a real decrease in revenue.
What is an example of loss of income? ›
Loss of income is a term that refers to wages and benefits lost due to an injury for which another individual or entity is liable. For instance, if an injury kept you out of work for a month, you would have a specific monetary amount to report for the time you could not earn money at your job.
Do you pay taxes on negative net income? ›
If a corporation has negative net income, it has no profit that the IRS can tax. Even if a corporation is not subject to income taxes due to zero profit, it may still have to pay other types of taxes related to its operations, such as labor-related taxes and excise taxes.
Why is my net cash negative? ›
The first thing negative cash flow tells you is that you're spending more money than your business makes. When you dig deeper, you could discover that you have; Increased Expenses and Overhead Costs. Outstanding Customer Payments.
Why do most businesses fail in their first year? ›
The NFIB concurs, and says that a lack of startup funds—or, being unable to come up with adequate financing—are both common reasons for business failure. “If you lack the cash or assets to start on your own, like most businesses, you will need to borrow,” it says. Poor cash flow.
Why do most small businesses fail in the first year? ›
The most common reasons small businesses fail include a lack of capital or funding, retaining an inadequate management team, a faulty infrastructure or business model, and unsuccessful marketing initiatives.
Why do companies have negative net worth? ›
Deficit net worth is a situation in which a person or a company's liabilities are greater than their assets. Also known as negative net worth, deficit net worth can occur for a variety of reasons, but it typically arises when current or future asset values erode unexpectedly.
What is the reason for negative net profit? ›
A negative profit margin is when your production costs are more than your total revenue for a specific period. This means that you're spending more money than you're making, which is not a sustainable business model. Many companies have negative profit margins depending on external factors or unexpected expenses.
