The Cash Flow Statement: Following the Money

How the cash flow statement tracks real cash coming in and going out, and why profitable companies can still run out of money.

Profit and cash are not the same. A company can report a profit but have no cash to pay its bills, or report a loss while its bank balance grows. The cash flow statement shows the actual cash moving in and out of a business over a period.

Three sections

The statement is divided into three parts:

Operating activities: cash from the company’s main business, such as customer payments received and wages and supplier bills paid. This is called operating cash flow.
Investing activities: cash spent on or received from long-term assets, such as buying machinery or selling a building. Spending on long-term assets is called capital expenditure.
Financing activities: cash from borrowing or issuing shares, and cash paid out to repay debt, pay dividends or buy back shares.

Why profit and cash differ

Several things make profit and cash diverge:

A sale is counted as revenue when made, even if the customer pays months later.
Buying a machine uses cash immediately, but its cost is spread across many years of profit as depreciation.
Building up inventory uses cash before the goods are sold.

Free cash flow

Investors pay close attention to free cash flow: operating cash flow minus capital expenditure. It shows how much cash the business generates after maintaining and expanding its assets. This cash can be used to repay debt, pay dividends or invest in growth.

The growing toy company

A toy company wins a big order from a retailer before the holiday season. It must buy materials and pay workers now, but the retailer will pay 90 days after delivery. On paper, the company is highly profitable. In reality, its cash is draining away while it waits to be paid. If it cannot borrow to bridge the gap, it could fail despite its profits. Fast growth can be dangerous for exactly this reason.

Ignoring cash because the company is profitable

Many businesses that fail were profitable on paper. They ran out of cash to pay suppliers, staff or lenders. Checking cash flow, not just profit, is one of the most important habits in understanding any company.

Key takeaways

The cash flow statement tracks actual cash moving in and out of a business.
It has three sections: operating, investing and financing activities.
Profit and cash differ because of credit sales, depreciation and inventory.
Free cash flow shows the cash left after maintaining and expanding the business.