Discuss the relations among cash flows from operating, investing, and financing activities for firms in the introduction, growth, mature, late maturity, and decline phases

Answer 1

RELATIONS AMONG CASH FLOWS FROM OPERATING, INVESTING, AND FINANCING ACTIVITIES

The product life-cycle concept from microeconomics and marketing provides useful insights
into the relations among cash flows from operating, investing, and financing activities.

During the introduction phase, cash outflow exceeds cash inflow from operations because operations are not yet earning profits while the firm must invest in accounts receivable and inventories. Investing activities result in a net cash outflow to build productive capacity. Firms must rely on external financing during this phase to overcome the negative cash flow from operations and investing.

The growth phase portrays cash flow characteristics similar to the introduction phase. The growth phase reflects sales of successful products, and net income turns positive. A growing firm makes more sales, but it also needs to acquire more goods to sell. Because it usually must pay for the goods it acquires before it collects for the goods it sells, the growing firm finds itself often short of cash from operations. The faster it grows (even though profitable), the more cash it needs. Banks do not like to lend for such needs. They view such needs (even though for current assets) as a permanent part of the firm's financing needs. Thus, banks want firms to use shareholders' equity or long-term debt to finance growth in nonseasonal inventories and receivables.

The maturing of a product alters these cash flow relations. Net income usually reaches a peak, and working capital stops growing. Operations generate positive cash flow, enough to
finance expenditures on property, plant, and equipment. Capital expenditures usually maintain,
rather than increase, productive capacity. Firms use the excess cash flow to repay borrowing
from the introduction and growth phases and to begin paying dividends to shareholders.

Weakening profitability—from reduced sales or reduced profit margins on existing sales—
signals the beginning of the decline phase, but ever-declining accounts receivable and inventories can produce positive cash flow from operations. In addition, sales of unneeded property, plant, and equipment can result in positive cash flow from investing activities. Firms can use the excess cash flow to repay remaining debt or diversify into other areas of business.

Biotechnology firms are in their growth phase, consumer foods companies are in their
mature phase, and U.S. auto manufacturers are in the late maturity or the decline phase.