Tag: EPS

How can a company operate with an accumulated deficit?First, when does this happen? The simple answer – the company keeps losing money. Why? Probably because the company is not economically viable. Something about the business model makes it unprofitable. The lack of profitability accumulates. Specifically, on the company’s balance sheet. Under retained earnings. Retained earnings represent the accumulation of earnings less any dividends paid out. But, in the case the company is losing money, retained earnings is referred to as accumulated deficit. How can a company persist with a deficit? An accumulated deficit is not the same as having negative cash. This is a common misconception. No company can have negative cash. This would suggest that the bank is giving the company money in its deposit accounts to fund the business. This is never the case. The bank will not give the company free money. The company’s cash balance must be non-negative. Take the following example. A company raises $100 and reports $0 in revenue and $50 in R&D over its first year of operations. In this case, the company’s cash is $50 (assuming it paid out the wages in full) while the retained earnings is -$50. So, retained earnings is not the same as cash. The company still has liquidity from $50 of cash. But, the equity investors have lost $50 of equity value through expensing R&D. This is seen by a decrease in the book value of equity. Assets went down $50 from paying the employees. Liabilities were unchanged, so the equity is less valuable to shareholders (assuming no assets were created from the R&D). Take Hello Fresh as an example. The company has been largely unprofitable. So, how does the company continue to operate?Well, without positive cashflows, the company must turn to other sources to finance the business. In the past, Hello Fresh was able to raise enough equity capital in order to thrive. Nonetheless, the company is burning through cash if it cannot fix its underlying business model shortfalls. At the other end, a company can generate earnings disproportionately to assets. This is common with most companies, which are much more valuable in the market than their book value of equity would suggest.

Tag: EPS

How can Companies with Negative Accumulated Earnings Operate?

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