Difficulty: Medium
Correct Answer: Yes, if cash flow is positive mainly because of borrowing or selling assets while core operations are weak or loss making.
Explanation:
Introduction / Context:
Many learners assume that positive cash flow automatically means a business is safe and profitable. However, the cash flow statement has three sections operating, investing and financing and not all positive cash flows are equally healthy. Interviewers like to ask whether a company can show positive cash flow and still be in serious difficulty, because this tests understanding of the structure of the cash flow statement and the difference between short term liquidity and long term viability.
Given Data / Assumptions:
Concept / Approach:
The key concept is that positive net cash flow can come from borrowing more money, selling assets or issuing new shares, even if the company operations are loss making. In such a case, cash balances rise in the short term, but the underlying business may be weak or collapsing. True health is better judged by sustainable positive cash flow from operating activities together with reasonable investing and financing patterns. Therefore, the correct option must state that yes, it is possible, especially when the positive cash flow results from financing and investing activities rather than strong operations.
Step-by-Step Solution:
Step 1: Recall the three sections of a cash flow statement and their meanings.
Step 2: Consider a scenario where operating cash flow is negative because the company spends more on salaries, materials and interest than it receives from customers.
Step 3: Imagine that the company sells a building or heavy equipment, creating a large inflow in the investing section.
Step 4: Alternatively, imagine that the company borrows heavily from banks or issues new shares, creating a large inflow in the financing section.
Step 5: From these scenarios, see that net cash flow can be positive even while the company fundamentals are weak, which supports the correct option.
Verification / Alternative check:
As an additional check, think about a start up that is burning cash on operations but constantly raising new rounds of funding. The cash flow from financing is strongly positive and may easily exceed the negative operating cash flow, so total cash increases. If investors suddenly lose confidence and stop funding, the company may collapse because operations are not yet self sustaining. Similarly, a mature firm might sell key assets to show positive cash in one year while its business model is declining. These examples show that positive net cash flow does not guarantee financial health, especially if driven by non operating sources.
Why Other Options Are Wrong:
Option B is wrong because it assumes a simple link between positive cash flow and health, ignoring the composition of cash flows. Option C is incorrect since the phenomenon can occur in any type of organisation, not only government owned companies. Option D is wrong because accounting standards permit companies in trouble to report positive cash flow if it reflects actual transactions. Option E is clearly incorrect since not preparing a cash flow statement does not change the underlying cash movements or solve financial problems.
Common Pitfalls:
A common pitfall is focusing only on the net increase or decrease in cash and ignoring whether cash is generated from normal operations or from one time actions and borrowing. Another mistake is to overlook heavy dependence on short term debt, which can create temporary positive cash but higher risk. Learners may also forget that a company can delay payments to suppliers and taxes to boost short term cash at the cost of future strain. Always examine the operating section separately and look at trends over several years when assessing financial health.
Final Answer:
Yes, if cash flow is positive mainly because of borrowing or selling assets while core operations are weak or loss making.
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