The cash flow statement
Profit is an opinion. Cash is a fact. This is the statement that reconciles the two.
A company can report a profit and run out of money. It can report a loss and accumulate cash. The cash flow statement exists because those two sentences are both true and neither is unusual.
Three sections, three questions
- Operating activities. Did the core business generate cash? This is the section that matters most.
- Investing activities. What did it spend on long-lived assets, and what did it sell?
- Financing activities. Did it borrow, repay, issue shares, buy back shares or pay dividends?
Why profit and cash separate
Accounting records revenue when it is earned, not when payment arrives. Sell something in March on ninety-day terms and March shows the profit while the cash appears in June. Meanwhile the cost of making it may have been paid in January.
A company growing quickly often shows healthy profits and negative operating cash flow, because it is buying inventory and extending credit to new customers faster than old customers pay. This is normal and it is also exactly what a failing company looks like, which is why the trend and the explanation both matter.
The number most investors end up using
Operating cash flow minus the money spent on property and equipment gives free cash flow — cash the business generated that was not required to keep it running. It has its own lesson, because it is the closest thing to what an owner actually gets: see free cash flow.
Over any single period the two can diverge for perfectly good reasons. Over five years, a company whose cumulative operating cash flow lags well behind its cumulative reported profit is telling you something about the quality of that profit.