Net income is not the balance in a company’s bank account. Start a cash review by tracing where money moved, then investigate the gap between profit and cash. A falling cash balance alone does not tell you whether operations consumed cash or a company repaid financing.
Separate three kinds of cash movement
Operating flows relate to the principal business, investing flows include acquiring or selling long-term assets, and financing flows cover funding such as borrowing and repayments. IAS 7 provides the framework; check how the particular filing classifies each item.
A fictional bridge from profit of 20 to cash of 7
All amounts in this example are in millions. It describes no real company and assumes there are no other adjustments.
| Bridge to operating cash | Amount |
|---|---|
| Net income | 20 |
| Add non-cash depreciation | +5 |
| Increase in receivables | −12 |
| Increase in inventory | −9 |
| Increase in payables | +3 |
| Operating cash flow | 7 |
The calculation is 20 + 5 − 12 − 9 + 3 = 7. Recognized sales may not yet have been collected, and inventory may have absorbed cash. The example does not establish that customers will default or that inventory is impaired. Those are separate questions requiring collection and inventory disclosures.
Reconcile the change in cash
Suppose opening cash is 30, operating cash is +7, equipment purchases are −10 and loan repayments are −4. With no currency effects or other movements, closing cash is 23. Cash fell by 7 while operations generated 7. Writing out all three streams avoids confusing these two statements.
A measure called free cash flow often subtracts capital expenditure from operating cash. Definitions and adjustments differ, so record the actual formula before comparing a company-defined figure with your own calculation.
Questions to take to the filing
- How did receivables and inventory change relative to sales?
- Which spending purchased equipment, and which acquired a business?
- What came from borrowing, repayments or dividends?
- How does ending cash reconcile to the balance sheet?
FirmLens summary cards do not currently contain cash flow figures. Open an annual source document from a company profile and use its cash flow statement and notes for this exercise.