A company can report healthy accounting profits and still be haemorrhaging cash. That's because profits are calculated after non-cash items and before the capital expenditure required to keep the business running. Free cash flow cuts through this — it shows you the actual cash left over once the business has paid its bills.
The formula
Operating cash flow is the cash generated from the business's core activities — selling products or services. It starts from net income and adjusts for non-cash items and working capital changes.
Capital expenditure (capex) is money spent on maintaining and upgrading physical assets — factories, machinery, stores, servers.
Why FCF beats reported profit
| Net Profit | Free Cash Flow | |
|---|---|---|
| Affected by accounting choices? | Yes — depreciation, revenue recognition | Much less so |
| Includes capex? | No | Yes |
| Reflects real cash available? | Not directly | Yes |
Maintenance vs growth capex
Not all capital expenditure is equal. Maintenance capex is money spent just to keep the business running — replacing worn-out equipment, fixing stores. Growth capex is optional investment to expand — opening new factories, building new data centres. Companies don't always split these out, which matters because growth capex is discretionary (you can cut it without the business deteriorating immediately) while maintenance capex isn't.
A business with high maintenance capex — like airlines, steel companies, or utilities — will always show lower FCF than a business with low maintenance needs, like a software company. This is why tech companies often have extraordinary FCF margins.
What this means for you
When evaluating any company, always check three things: Is FCF positive? Is it growing? And is it roughly in line with reported profits? A sustained gap between profits and FCF — especially if profits are well above FCF — warrants investigation. Companies that generate strong, consistent FCF have enormous flexibility: they can survive downturns, return cash to shareholders, and make acquisitions without needing external financing. That's a powerful advantage over time.
Revenue is vanity, profit is sanity, cash flow is reality. Free cash flow is the number that tells you whether a business is truly working.