TRADE
CORPORATE FINANCE FINANCIAL STATEMENTS
What Factors Decrease Cash Flow From Operating Activities?
By BRIAN BEERS Updated May 01, 2023
Reviewed by CHARLENE RHINEHART
Fact checked by SUZANNE KVILHAUG
Operating cash flow is the cash flow generated from the regular activities of a business. Operating cash flow starts with net income from the income statement, adds back in cash, and then incorporates any changes (adding or subtracting) in working capital.
To create a strategy that avoids declines in cash from operations, businesses should focus on maximizing net income and optimizing efficiency ratios.
The following factors will all decrease cash flow from operating activities:
1. Decrease in Net Income
The cash flow statement begins with net income, which is equal to revenues minus all costs, including taxes.
1
As operating cash flow begins with net income, any changes in net income would affect cash flow from operating activities. If revenues decline or costs increase, with the resulting factor of a decrease in net income, this will result in a decrease in cash flow from operating activities.
2. Changes in Working Capital
The most significant uses of cash from operating activities are the changes in working capital, which includes current assets and current liabilities. Increases and decreases in current assets and liabilities are reflected in the cash flow statement. Growth in assets or decreases in liabilities from one period to another constitutes a use of cash and reduces cash flows from operations.
Working capital management is evaluated by efficiency ratios such as inventory turnover, days sales outstanding, and days payable outstanding.
Lower Inventory Turnover
Inventory turnover is calculated by finding the ratio of sales in a period to inventories at the end of the period. Lower inventory turnover usually indicates less effective inventory management. Poor inventory management expands the level of inventories on the balance sheet at any given time, meaning inventory is not being sold. This is a use of cash that decreases cash flows from operations.
Growth in Days Sales Outstanding
Days sales outstanding measures how quickly a company collects cash from customers. This metric is calculated by multiplying the number of days in a period by the ratio of accounts receivable to credit sales in the period. If days sales outstanding grows, it indicates poor receivable collection practices, meaning a company isn't getting paid for items it sold. This leads to higher current assets, constituting a use of cash that decreases cash flows from operating activities.
Decline in Days Payable Outstanding
Days payable outstanding measures how quickly a business pays its suppliers. It is calculated by multiplying days in the period by the ratio of accounts payable to cost of revenues in a period. When days payable outstanding declines, the time it takes for a company to settle up with its suppliers declines, meaning it is paying its suppliers faster and money is out the door sooner. This reduces accounts payable on the balance sheet. Reducing current liabilities is a use of cash, and this decreases cash flows from operations.
The Bottom Line
Cash flow from operations is an important metric that tells how much cash a company is generating from its business activities. It derives much of its function from the income statement and the balance sheet statement, such as net income and working capital. A change in the factors that make up these line items, such as sales, costs, inventory, accounts receivable, and accounts payable, all affect the cash flow from operations.
ARTICLE SOURCES
Related Articles
TOOLS
How Do Net Income and Operating Cash Flow Differ?
Business team going over things
FINANCIAL RATIOS
What Is the Formula for Calculating Free Cash Flow?
FINANCIAL STATEMENTS
How to Evaluate a Company's Balance Sheet
dollar bill coming out of a tap
FINANCIAL STATEMENTS
What Changes in Working Capital Impact Cash Flow?
A man holding up chalk drawings related to cash flow
ACCOUNTING
Cash Flow Analysis: The Basics
On-Line Processing Orders From Storage Room
TOOLS
How Do You Analyze Inventory on the Balance Sheet?
Related Terms
Working Capital Management Explained: How It Works
Working capital management is a strategy that requires monitoring a company's current assets and liabilities to ensure its efficient operation. more
Working Capital: Formula, Components, and Limitations
Working capital, or net working capital (NWC), is a measure of a company’s liquidity, operational efficiency, and short-term financial health. more
Acid-Test Ratio: Definition, Formula, and Example
The acid-test ratio is a strong indicator of whether a firm has sufficient short-term assets to cover its immediate liabilities. more
Cash Flow: What It Is, How It Works, and How to Analyze It
Cash flow is the net cash and cash equivalents that move in and out of a company's financial statement. more
Current Ratio Explained With Formula and Examples
The current ratio is a liquidity ratio that measures a company’s ability to cover its short-term obligations with its current assets. more
Free Cash Flow (FCF): Formula to Calculate and Interpret It
Free cash flow (FCF) represents the cash a company can generate after accounting for capital expenditures needed to maintain or maximize its asset base. more
