Profit and free cash flow: reconcile the difference
Profit and cash flow answer different questions. Accounting records revenues and expenses under recognition rules; cash flow tracks movements of money. Free cash flow is commonly calculated as operating cash flow minus capital expenditure, but definitions can vary.
From $30 million of profit to $5 million of free cash flow
Suppose a company reports $30 million of profit. Depreciation adds back $10 million in a simplified cash-flow reconciliation, while increased receivables consume $15 million. Ignoring other items, operating cash flow is $25 million.
If capital expenditure is $20 million, the stated free-cash-flow calculation gives $5 million. The $30 million profit and $5 million free cash flow describe different aspects of the same year.
Read the components
Receivables may reflect growth or slower customer payments. Inventory can prepare the business for demand or signal unsold goods. You need the notes and subsequent periods to distinguish those possibilities.
Capital expenditure can maintain existing assets or expand capacity. Companies do not always disclose that split precisely. Write down the available evidence rather than inventing a clean distinction.
A research framework should keep the reconciliation beside the headline measure. Check whether a company’s advertised free cash flow includes adjustments or excludes costs you consider relevant.
Borrowing increases cash through financing activity. It does not become cash generated by operations. Likewise, selling an asset can increase cash without showing recurring operating strength.
Compare several periods using the same definition. One year’s cash-flow surge may include a working-capital reversal that cannot recur at the same scale next year.