Fundamental analysis · Intermediate

Understanding the Cash Flow Statement

Profit is calculated under rules. Cash is a bank balance. When the two diverge for two years running, one of them is describing the business.

Last reviewed 15 September 2026 by the MarketPro research desk · Editorial policy

In short

The cash flow statement tracks money actually entering and leaving a business, split into operating, investing and financing activities. It differs from reported profit because accounting rules decide when a sale is recognised and how costs are spread, while cash is a bank balance. Free cash flow, operating cash flow minus capital expenditure, is what the business genuinely has available after maintaining its asset base.

What to remember

£48m of net income can be £11m of free cash, with the gap sitting in unpaid invoices and unsold inventory.
Receivables and inventory both rising faster than revenue, two years running, is a pattern rather than a timing effect.
Negative operating cash flow with positive financing cash flow, sustained, means the business is funded from outside itself.
Cash flow is flattered by stretching supplier terms and by cutting maintenance capex, so average capital expenditure over three to five years.

Lesson 10 of 24 in Fundamental analysis

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The cash flow statement records money actually moving in and out of a business, which is a different question from whether it made a profit. Profit is calculated under accounting rules that decide when a sale counts and how a cost is spread. Cash is a bank balance. When the two diverge sharply and stay diverged, the cash statement is usually the one telling the truth.

£48m of profit, £11m of free cash

Take a company reporting £48m of net income for the year and follow the cash.

Line	Amount
Net income	£48m
Add back depreciation and amortisation	£22m
Increase in receivables	(£31m)
Increase in inventory	(£14m)
Increase in payables	£6m
Operating cash flow	£31m
Capital expenditure	(£20m)
Free cash flow	£11m

The headline said £48m. The business generated £11m it could actually use. The gap is almost entirely working capital: £31m more is owed by customers than last year and £14m more is sitting in a warehouse. Both were recognised as revenue or held at cost, and neither is money in the bank.

That pattern has a specific interpretation. Receivables rising much faster than revenue usually means the company is selling on looser terms to keep the sales number growing, or that customers are struggling to pay. Inventory rising faster than revenue usually means product is not selling as fast as it is being made. Either can be a temporary timing effect. Both, in the same year, for a second consecutive year, is a pattern worth taking seriously.

Note what depreciation is doing in that table. It was subtracted when profit was calculated because the assets are wearing out, but no money left the building this year. The money left years ago when the equipment was bought, and it appears further down as capital expenditure. Adding £22m back and then subtracting £20m of capex is the statement asking a sharper version of the same question: is the company spending more or less than the rate at which its asset base is being consumed? Here it is spending slightly less, which is fine for a year and a problem for a decade.

The three sections, and the combination to worry about

Operating. Cash from running the business. Should be positive and, over time, comfortably larger than net income because depreciation is added back.
Investing. Usually negative in a growing company, because it is buying equipment and making acquisitions. Positive investing cash flow often means the company sold something, which is worth knowing about.
Financing. Borrowing, repayment, share issues, buybacks and dividends. Persistently positive financing cash flow means the business is funded from outside rather than by itself.

The combination that should stop you is negative operating cash flow paired with positive financing cash flow, sustained across several years. It means the business consumes cash and borrows or issues shares to cover the gap. That is a normal and reasonable position for an early-stage company that has said so. It is a different thing entirely in a mature business reporting steady accounting profits.

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Free cash flow is not a standardised number

Operating cash flow minus capital expenditure is the common definition, and it is a good one, but companies publish their own variants. Some subtract only maintenance capex and not growth capex. Some add back acquisition costs. Some exclude lease payments that are economically identical to rent.

So when a company quotes its free cash flow, find the two underlying figures and do the subtraction yourself. It takes thirty seconds and it removes the definitional argument entirely. The same applies to any adjusted figure: the raw components are in the statement, and the adjustment is a presentational choice made by people with an interest in the outcome.

Where the cash statement misleads in the other direction

It has a symmetric weakness. Cash flow can be flattered as easily as profit, just through different levers. Stretching supplier payment terms increases payables and boosts operating cash flow in the year it happens, then stops helping. Cutting capital expenditure below the level needed to maintain the asset base raises free cash flow now and lowers output later. Selling receivables to a factoring company converts future cash into present cash and looks like collection improving.

Capital expenditure is also lumpy by nature. A company that builds a factory every seven years will show terrible free cash flow in year one and excellent free cash flow in years two to seven, and neither figure describes the underlying business. Averaging capex across three to five years is the standard correction.

A four-quarter cash check

Line up four things for the last four quarters: net income, operating cash flow, capital expenditure and the change in receivables. Then answer three questions. Is operating cash flow consistently above net income? Are receivables growing slower than revenue? Is free cash flow positive across the full four quarters taken together rather than just in the best one?

Three yes answers is a business converting profit into cash. One or more no answers is not a verdict, it is a reason to read the notes and find out why. Cash flow is where accounting flexibility runs out fastest, which is exactly why it is the statement to check when the reported profit and the share price disagree. And a company that is quietly consuming cash tends to announce it abruptly, which is an argument for holding it in a size that survives the announcement rather than one that depends on it not coming, the logic set out in the risk rules.

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MarketPro is a trading-signal and trading-education app operated by Harajuku Holdings LTD (Cyprus). Our signal desk publishes and tracks every trade idea in-app, and every page here is checked against the app's live behaviour before publishing. Last reviewed 15 September 2026. How we produce signals and content · About MarketPro

FAQ

Understanding the Cash Flow Statement: questions

Can a profitable company run out of cash?

Yes, and it is one of the most common ways businesses fail. A company can report growing profit while every sale is made on credit, so revenue is recognised but no money arrives. Wages, suppliers and interest still have to be paid in cash. If receivables grow faster than collections, the company becomes insolvent on cash while remaining profitable on paper, which is exactly what the cash flow statement is designed to reveal.

Why is depreciation added back to net income?

Depreciation spreads the cost of an asset over its useful life, so it reduces reported profit each year without any money leaving the business in that year. The cash already left when the asset was bought, and that outflow appears separately under investing activities as capital expenditure. Adding depreciation back removes a non-cash charge so the statement reflects actual cash movement.

What is a healthy free cash flow figure?

There is no universal number, but two relationships are informative. Free cash flow should be positive across a full cycle rather than in a single good year, and operating cash flow should generally exceed net income because non-cash charges are added back. A company converting less than its reported profit into operating cash, repeatedly, is worth examining before any valuation ratio is applied to it.

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