Question

The Arizona Corporation reported positive net income but negative cash flow from operations. Further, despite the negative cash flow from operations, the company continued to pay its regular dividend on its common shares. Discuss why it is possible for a company to report positive net income when the cash flow from operations is negative. Do you agree with the firm’s strategy of maintaining its regular dividend? Why or why not?

Answer 1

A company can report positive net income even when having a negative cash flow from operations. This is because net income is a sign or indicator of liquidity and so a company with a positive net income is a liquid company. Cash flow from operations indicates whether the liquid assets of a company are increasing or decreasing. In case when the cash flow from operations is negative then this indicates that the liquid assets of the company are declining. Negative cash flows can also be a reflection of poor timing of income and expenses. It should be noted that cash flow from operations = net income + non- cash expenses (like depreciation and amortization) – increase in working capital.

I agree with the firm’s strategy of maintaining its regular dividend because for dividend payments a company should look at its free cash flows. Free cash flow is the surplus/discretionary cash that a company is able to generate. Thus a company can still pay dividends even if its cash flow from operations is negative. It should be noted that dividend payments are related to cash flow from financing activities of a company.