The Cash Flow Statement: Where the Cash Actually Went

Net income was $100 million. So where is the $100 million?

Some of it is in the bank, some is owed by customers who haven’t paid yet, and some was never cash to begin with. The cash flow statement sorts that out. It starts from the profit on the income statement, walks through every adjustment, and ends at the change in the cash balance you saw on the balance sheet.

How the statement is laid out

Every cash flow statement splits cash into the same buckets.

Operating activities cover the cash the business itself produces or uses: collections from customers, payments to suppliers and staff, interest and taxes. Investing activities cover buying and selling long-lived assets, such as equipment, whole businesses and investment securities. Financing activities cover the money that comes from or goes back to lenders and shareholders, which means borrowing, repaying debt, issuing shares, buying them back and paying dividends.

Add the section totals and you get the change in cash for the period.

In a Form 10-Q, the cash flow statement is usually shown year to date. A third-quarter 10-Q gives nine months of cash flow, with no separate column for the quarter alone, so to isolate the third quarter you subtract the six-month figures in the second-quarter 10-Q from the nine-month figures in the third, which is tedious but the only way to see one quarter’s cash on its own.

From net income to operating cash flow

Most companies present the operating section by the indirect method. It opens with net income and then adjusts.

Non-cash charges get added back. Depreciation is the usual one: it spreads the cost of old equipment purchases across years, lowering profit each period, but no money leaves in the period it is charged. Stock-based compensation is another add-back, which is why a company that pays staff heavily in shares can show operating cash flow well above its net income. The column arguing that stock-based pay is a real cost takes that add-back apart.

Then come the working capital lines. More money owed by customers means cash that was booked as revenue but not yet collected, so an increase in receivables is subtracted. A build in inventory is subtracted too. A rise in what the company owes suppliers is added, since the company kept that cash for now.

Free cash flow

Capital spending sits in the investing section, as purchases of property and equipment. Subtract it from operating cash flow and you have free cash flow: the money left after keeping the business running and growing, available to pay down debt, pay dividends, buy back shares or simply sit in the bank. Here it’s $65 million on $100 million of net income.

Free cash flow is not a GAAP line. Companies define it in their own way, and when they report it in an earnings release they have to show how it reconciles to the GAAP figures.

When earnings and cash disagree

In a single quarter, a gap between net income and operating cash flow means very little. A big customer paid a week late. Inventory was built for a busy season.

A gap that repeats deserves questions.

Take the same hypothetical company and change one line. Suppose receivables rose by $90 million, up from $20 million in the first version. Operating cash flow becomes 100 plus 30 minus 90, or $40 million, and after $45 million of capital spending free cash flow is minus $5 million, so the company reported a $100 million profit and ended the period with less money than it would have had by doing nothing at all. One quarter like that has explanations. Quarter after quarter, it means sales are being booked well ahead of the cash, and the answer on revenue against earnings lists where that tends to come from.

Where the statement stops

Cash flow can be managed too. A company can delay paying suppliers at quarter end to flatter operating cash flow, or sell its receivables to a lender for cash today, and either move makes one quarter look stronger by borrowing a little from the next, which is why a run of several quarters tells you far more than any single figure. Browse the earnings section for more on reading results.

The last lesson puts all of it to work on the document most traders see first, the earnings release, and on the guidance line that often draws more attention than the quarter just reported.