The three sections of the cash flow statement
Operating cash flow (OCF) starts with net income and adjusts for non-cash items (adding back depreciation, amortisation) and working capital changes (if customers owe you more money, you’ve "earned" revenue but haven’t received cash). This is the most important section: it shows whether the core business generates or consumes cash. Investing cash flow shows capital expenditure on assets — factories, equipment, acquisitions. Financing cash flow shows debt raised or repaid, dividends paid, and shares issued or bought back.
Free cash flow — the gold standard metric
Free cash flow (FCF) = Operating cash flow − Capital expenditure. It represents cash the business generates that is genuinely free — available to pay down debt, pay dividends, buy back shares, or accumulate. It is the metric most closely linked to long-run share price performance because it underpins dividend sustainability and is harder to manipulate than earnings. High-quality businesses generate FCF consistently in excess of net income; lower-quality businesses often see the opposite — they report profits but consume cash.
When profit and cash diverge
Profitable businesses can run out of cash. The classic scenario is rapid growth: a business that doubles sales must also double its working capital (more inventory, more receivables) — and if the growth is faster than cash collection, the business consumes cash despite making profits. This "overtrading" has caused the collapse of many apparently successful businesses. The opposite also occurs: a business can generate strong cash flow despite reporting accounting losses (through high depreciation). Cash flow analysis cuts through these accounting complexities.
“More businesses die from cash starvation than from lack of profit. Profit is an opinion; cash is a fact.”
What this means for you
For any business you are evaluating — as an investor, lender, or business owner — check that it converts profit into cash. Calculate the cash conversion ratio (OCF / net income) and the FCF yield. Be particularly sceptical of fast-growing companies that show strong revenue and profit growth but consume cash: they are dependent on continued external funding. The businesses that survive recessions and generate wealth for shareholders over decades almost always have one thing in common — they generate more cash than they spend.