Cash Flow & Free Cash Flow

Cash flow tracks the actual money moving in and out of a company, as opposed to accounting profit, which can include non-cash items. The cash flow statement splits it into three buckets: operating, investing, and financing. Free cash flow is what is left from operating cash after paying for the equipment and investment needed to keep the business running.

Investors focus on cash flow for a few reasons:

• Operating cash flow shows whether the core business actually generates cash, not just paper profit. Profit without cash flow is a warning sign.
• Free cash flow = operating cash flow − capital expenditures. It is the cash truly available to pay dividends, buy back shares, cut debt, or reinvest.
• Cash vs earnings: net income can be shaped by accounting choices, but cash is harder to fake, so investors cross-check the two.
• Watch the source: rising free cash flow is healthy, but cash raised by selling assets or piling on debt is lower quality than cash from operations.

A firm generates $40M in operating cash flow and spends $15M on new equipment (capex). Its free cash flow is $25M, the amount it can return to shareholders or reinvest without borrowing, even if its reported net income is a different number entirely.