The cash flow statement explains why cash increased or decreased during a period. It connects the profit reported on the income statement with changes in the balance sheet.
This is a simple introduction. Real statements have more adjustments and should be read with their notes.
The three sections
Fictional Lumen Coffee starts the year with €17.5m of cash and ends with €20m. Its simplified statement, in millions, is:
| Cash-flow section | Amount | What happened |
|---|---|---|
| Operating cash flow | €19.5m | Cash generated by the business operation |
| Investing cash flow | −€8m | Equipment and store investment |
| Financing cash flow | −€9m | Debt repayment and dividends |
| Net change in cash | €2.5m | Cash rose from €17.5m to €20m |
Operating + investing + financing cash flow = change in cash, apart from effects such as exchange rates in real reports.
Operating cash flow: profit converted into cash
Lumen reported €16.5m of net income, but operating cash flow is €19.5m. The reconciliation may look like this:
- Net income: €16.5m
- Add back depreciation, a non-cash expense: +€5m
- More cash tied up in inventory and receivables: −€2m
- Operating cash flow: €19.5m
The working-capital adjustment is important. A company can report a sale before collecting the money, or buy inventory before selling it. One year can be noisy, so follow the relationship over time.
Investing cash flow and CapEx
Lumen spends €8m on equipment and new stores. This is capital expenditure or CapEx: money invested in assets expected to support more than one period.
Negative investing cash flow is not automatically bad. It can represent productive expansion. Ask what was purchased, whether the spending is recurring and whether previous investments generated adequate returns.
Financing cash flow
This section shows cash moving between the company and its providers of capital. Lumen repays €5m of debt and pays €4m in dividends, so financing cash flow is −€9m.
Borrowing, issuing shares, repaying debt, buying back shares and paying dividends appear here. Positive financing cash flow often means the company raised money; it does not necessarily mean the business generated it.
Free cash flow
A common simple calculation is:
Free cash flow = operating cash flow − CapEx
For Lumen: €19.5m − €8m = €11.5m.
Free cash flow is cash left after running the operation and investing in long-term assets. It can support debt repayment, dividends, acquisitions or additional investment. It is not a perfect figure: classifying maintenance versus growth CapEx requires judgment.
For a deeper treatment, continue with how to analyse free cash flow.
Five questions for a first reading
- Does operating cash flow broadly follow net income over several years?
- Which working-capital changes explain the difference?
- How much CapEx is needed to maintain and grow the business?
- Are dividends and buybacks covered by internally generated cash?
- Is the company raising debt or shares to cover recurring cash shortfalls?
Together, the three statements form one system. Use the financial-statement glossary when a term is unfamiliar, then move to the fundamental-analysis guide for a complete process.
Common questions
Why is cash flow different from net income?
Net income follows accounting recognition rules. Cash flow adjusts for non-cash expenses and timing differences, then records actual investment and financing cash movements.
Where does free cash flow appear in the accounts?
It is usually calculated rather than reported as a required line: operating cash flow minus capital expenditure is the common simple version.
This is an introductory educational explanation, not accounting or investment advice. Definitions can vary between companies and data providers.