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The Impact of Cash Flow on R&D Intensity

June 14th, 2016

Does the amount of cash flow obtained by companies affect the level of investment in research and development (R&D)? To answer this, we look at empirical research to investigate the impact of cash flow on R&D expenditure.

Firstly, cash flow can be defined as the movement of cash into or out of a business, project or financial product. In this particular case, the movement of cash into R&D expenditure. Previously, a large number of empirical literature has quantified the role of financial resources in the funding of R&D. In specific, studies have found that the firm’s ability to generate funds internally is particularly important for financing innovation projects and show a positive correlation between R&D investment and changes in cash flow (Fazzari, Hubbard and Petersen (1988), Leland and Pyle (1977), Hall (1992), Bhagat and Welch (1995), Himmelberg and Petersen (1994), Bond, Harho and Van Reenen (2005), and (Bougheas, Gˆrg and Strobl (2003)).

In fact, according to Rafferty and Fund (2005) , cash flow concerns the ability, and willingness, of companies to engage in innovative activities  (such as R&D). Moreover, based on their empirical studies they discovered an increase in cash flow stimulates R&D.

As the above reveals, the positive relationship between cash flow and R&D expenditure means enhancement in firm’s cash flow can increase their R&D expenditure. Nonetheless, it is important to note that R&D expenditure is not only influenced by cash flow but also influenced by factors such as policies, innovation  performance, and culture.

If you believe your company could benefit from an increase in cash flow for R&D activities,  Swanson Reed has just introduced a new R&D tax refund financing service to our clients claiming the R&D Tax Incentive. With an R&D Tax Offset Financing service, companies undertaking R&D projects are able to receive the benefits of the AusIndustry R&D cash rebates prior to receipt from the Government. See our service page for more information on this funding.

 

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If you want to read more about cash flow and R&D expenditure, the literature referenced is as follows:

• Bhagat, Sanjai and Ivo Welch (1995), “Corporate Research and Development Investments – International Comparisons,” Journal of Accounting and Economics, Vol. 19, pp. 443-470.
• Hall, Bronwyn H. (1992), “Research and Development at the Firm Level: Does the Source of Financing Matter?,” NBER Working Paper No. 4096.
• Himmelberg, Charles P. and Bruce C. Petersen (1994), “R&D and Internal Finance: A Panel Study of Small Firms in High-Tech Industries,” Review of Economics and Statistics, Vol. 76, pp. 38-51
  Fazzari, Steven M., R. Glenn Hubbard and Bruce C. Petersen (1988), “Financing Constraints and Corporate Investment,” Brooking Papers on Economic Activity, Vol. 1, pp. 141-206.
• Leland, Hayne E. and David H. Pyle (1977), “Informational Asymmetries, Financial Structure, and Financial Intermediation,” Journal of Finance, Vol. 32, No. 2, pp. 371-387.
• Rafferty, Matthew and Mark Funk (2005), “Asymmetric Effects of The Business Cycle on Firm-Financed R&D,” Department of Economics, Quinnipiac University, Mount Carmel Ave