How can a company be profitable but have negative cash flow?

Sales may be booked before the cash arrives, or cash may be tied up in inventory and equipment. That can be normal for a fast-growing company for a while, but if it persists it is a warning sign.

How do you calculate free cash flow?

Usually as cash from operating activities minus capital expenditure (capex). Both figures are on the cash flow statement.

Analysis

What is Cash flow statement?

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In short

Shows how much cash actually came in and went out, in three parts: operating, investing and financing activities.

The cash flow statement shows how much cash actually came in and went out during a period. Profit on the income statement is recorded on an accrual basis; this statement tracks real money — which makes it harder to dress up.

Three sections

Operating activities — cash from the core business. It starts from net income, adds back non-cash items (depreciation, stock-based pay) and adjusts for working capital changes (receivables, inventory).
Investing activities — spending on equipment and buildings (capex), acquisitions, investments.
Financing activities — borrowing and repaying debt, paying dividends, buybacks, issuing new shares.

The key figure

Operating cash flow minus capex leaves free cash flow (FCF). That is the money available for dividends, buybacks or paying down debt.

Warning sign

If net income rises year after year while operating cash flow stays well below it, the profit may be staying "on paper" (for example, customers are not paying). Look at a multi-year trend, not one quarter.

Free cash flow (example, $m)

Net income$22

Operating cash flow$30

Capital spending (capex)$10

Free cash flow (FCF)$20 · operating − capex

Profit is an accounting number; cash flow is money that actually came in. FCF is what is left after investment — it can pay dividends or debt.

Example

A hypothetical company, one year ($ millions):

Operating activities

Net income 100, + depreciation 40, − increase in receivables 30 → 110

Investing activities

Capex −60 → −60

Financing activities

Dividends −20, buybacks −15, new debt +10 → −25

Change in cash: 110 − 60 − 25 = +25.
Free cash flow: 110 − 60 = 50.

Comparison: another company also has net income of 100, but its receivables grew by 80, so operating cash flow is only 60 ($100 + $40 − $80). Same profit, much less cash — worth investigating.

Mistakes and tips

Compare operating cash flow with net income every year — over the long run they should be close.
Stock-based compensation is added back to operating cash flow, but it is a real cost to shareholders through dilution.
Constant new debt or share issuance in the financing section can mean the business cannot fund itself.

Frequently asked questions

How can a company be profitable but have negative cash flow?: Sales may be booked before the cash arrives, or cash may be tied up in inventory and equipment. That can be normal for a fast-growing company for a while, but if it persists it is a warning sign.
How do you calculate free cash flow?: Usually as cash from operating activities minus capital expenditure (capex). Both figures are on the cash flow statement.

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