Financing a Loss

Abstract

When companies have a net loss accompanied by negative operating cash flows, they must decide how to handle the financing deficit, or, stated differently, they must decide how to finance the loss.  By examining a large sample of firms with net losses, we document how companies respond to the financing shock that occurs with negative cash flow.  For companies with a one-year loss, current assets decrease and current liabilities increase.  While we observe that leverage ratios increase during a loss year, this increase has more to do with decreasing book equity than an increase in long-term debt.  However, when the loss persists into a second year, companies make more fundamental changes, often downsizing by decreasing fixed assets and by issuing longer term debt.