Final answer:
New companies experiencing rapid sales growth may see increases in accounts such as accounts receivable and inventory, which can lead to discrepancies between net income and operating cash flows. To grow, companies reinvest profits, but early-stage firms may struggle due to a lack of customers and profits, hence they explore various sources of capital. Strategic reinvestment and capital raising are crucial for sustainable growth.
Step-by-step explanation:
New companies often experience rapid sales growth, leading to increases in sales-related asset accounts such as accounts receivable and inventory. This growth can drive a divergence between net income and operating cash flows. While net income reflects the sales made on credit, the actual cash may not yet be received, which affects the operating cash flows. Conversely, a buildup in inventory represents cash that has been spent but not yet translated into sales, again impacting cash flows.
One way firms manage this challenge is by reinvesting profits from sales into the business, which can promote further growth and an increase in assets. However, early-stage companies might struggle with profit reinvestment, as they may have few customers or even none at all, leading to the difficulty of raising financial capital. For such firms, sources of capital may include early-stage investors, borrowing, or selling stock. It's important that these firms manage their growth to ensure that the reinvested capital is more than the depreciation costs.
Firms make strategic decisions, including raising financial capital to fund immediate expenditures with an expectation of future profits. During their growth phase, businesses carefully consider their reinvestment strategies and capital raising methods to support sustainable expansion and avoid cash flow issues despite their growth in sales and assets.