PosiStep 13: Cash flow: why profit and cash can differ
A company can report a profit and still run out of cash. The cash flow statement shows the real money coming in and going out, and is often the hardest statement to dress up.
Why profit and cash differ
Profit is counted when a sale is made, even if the customer pays months later. If customers delay payment or the company builds up unsold stock, profit can look healthy while cash drains away.
Some costs, such as depreciation, reduce profit without any cash leaving that year. So cash and profit rarely match exactly.
Cash from operations
Operating cash flow is the cash the core business actually generates: money from customers minus money paid to suppliers, staff and the taxman. Over several years, a healthy company's operating cash flow is usually positive and broadly in line with its profit.
Cash for investing
Investing cash flow covers buying or selling long-term assets: new factories, machines, other businesses, investments. Spending on factories and machines is called capital expenditure (capex). This line is usually negative for a growing company, which is normal.
Cash from financing
Financing cash flow covers money raised or returned: new borrowings and share issues bring cash in; loan repayments, dividends and buybacks send cash out. A company that keeps borrowing just to pay its bills is a warning sign.
Free cash flow
Free cash flow = operating cash flow − capital expenditure. It is the cash left after keeping the business running and growing, available for dividends, buybacks, paying debt or saving.
Steady positive free cash flow is a sign of strength; years of negative free cash flow mean the company depends on borrowing or new shares.
Where PositoAI fits
The Go Deep tab shows each company's cash flow for recent years, next to its profit, so you can compare the two.
Key terms
- Cash flow statement
- Shows actual cash coming in and going out over a period.
- Operating cash flow
- Cash generated by the core business.
- Investing cash flow
- Cash spent on or received from long-term assets and investments.
- Financing cash flow
- Cash from or to borrowings, share issues, dividends and buybacks.
- Capex
- Capital expenditure: spending on factories, machines and similar assets.
- Free cash flow
- Operating cash flow − capex.
Try it
Made-up company Birch Foods generated ₹300 Cr of operating cash flow and spent ₹120 Cr on new machines (capex). What is its free cash flow?
Free cash flow = ₹300 Cr − ₹120 Cr = ₹180 Cr, cash left over after investing in the business.
See it live on PositoAI
Open Infosys's Go Deep tab and compare its net profit with its operating cash flow for the latest year. Are they of similar size?
What this does not tell you
One year of weak cash flow is not always bad; a company may be building stock before a busy season. Look at several years. Cash flow also says nothing about whether the share price is reasonable.
Quick quiz
Why can a profitable company run short of cash?
Profit is recorded at the sale; if customers pay late or unsold stock grows, cash can fall even with profits.
Which part shows cash from the core business?
Operating cash flow is the cash the main business generates.
Paying dividends appears in:
Dividends, buybacks, borrowing and repaying loans are financing cash flows.
Operating cash flow ₹500 Cr, capex ₹200 Cr. Free cash flow?
Free cash flow = ₹500 Cr − ₹200 Cr = ₹300 Cr.
Which is a warning sign?
Needing new loans every year to cover running costs suggests the business does not generate enough cash.
Answer every question on this page correctly to complete this PosiStep.
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PosiCourse is for education only. It does not recommend buying or selling any share. Examples with made-up numbers are not real companies. PositoAI is for research and education only and is not investment advice.