Reading a Cash Flow Statement

A company can report a profit every year for a decade and still run out of money. The income statement and the cash flow statement are answering two different questions, and only one of them is about survival.

Three sections, three questions#

Section	Question it answers	What to watch
Operating	Does the core business generate cash?	Should track profit over time
Investing	What is being spent to stay competitive?	Heavy, recurring capex
Financing	Who is funding the gap?	Cash from debt, not operations

Operating cash flow is the one that matters most. It strips out the accounting judgements — when revenue is recognised, how quickly assets are depreciated — and asks whether customers actually paid.

The gap that tells you the most#

Compare net profit to operating cash flow over five years. In a healthy business they move together. When profit climbs while operating cash flow stays flat, something is absorbing the difference, and it is usually one of two things: money owed by customers who have not paid, or inventory that has not sold.

Neither is automatically a problem. A company growing quickly will tie up cash in receivables and stock — that is what growth costs. The signal is the persistence. A gap that appears in one year is a working-capital swing; a gap that widens every year for five is a business that converts sales into cash badly, and eventually it will need someone else's money to keep going.

Free cash flow#

Subtract capital expenditure from operating cash flow and you have free cash flow — what is genuinely left over. This is the number that can pay down debt, buy back shares, or fund a dividend without borrowing.

A business is worth the cash it can take out over its life, discounted back. Everything else is an approximation of that.