How to read cash flow statements to determine if a company really has free cash

When a company releases its quarterly or annual results, most novice investors tend to first look at revenue and net income . If the number is green, they think everything is going well; if it's red, they get alarmed. But the reality is that those two pieces of data don't always tell the whole story.

There are companies that report accounting profits, but are actually losing money . How can this happen? Because profits are calculated under accounting rules (such as depreciation, amortization, or deferred revenue recognition) that don't necessarily reflect the actual cash flow.

For this reason, professional investors and financial analysts always pay special attention to the cash flow statement .

This document allows you to see the actual movement of money within the company: how much comes in, how much goes out, and, above all, if any money is left over at the end.

In this article, you'll learn step-by-step how to read this financial statement and how to use it to identify whether a company is actually generating free cash , that is, money available after covering its operations and investment needs.

Let's analyze how to read cash flow statements

1. What is the cash flow statement and why is it so important?

The cash flow statement (also known as the statement of cash flows ) is one of the three main financial reports along with the income statement and the balance sheet .

While the income statement shows you income and expenses (even if some are non-cash), and the balance sheet reflects the financial position at a given point in time, the cash flow shows you how the real money moves .

In short:

• The income statement tells you whether a company is profitable “on paper.”

• Cash flow tells you whether that profitability translates into hard cash.

This is key because a company can have positive accounting profits but run out of money to pay its bills, salaries, or debts.

Therefore, investors who understand cash flow can detect liquidity problems or the true drivers of a company much earlier.

2. The three sections of the cash flow statement

Cash flow is divided into three main parts:

a) Cash flow from operating activities (CFO)

It's the heart of the business. It shows how much cash the company generates from its core operations: selling products, providing services, paying suppliers, collecting payments from customers, etc.

A positive and growing CFO is usually a sign of a healthy company. If a company makes money selling its products, its operating cash flow should be positive.

On the other hand, if you see that operating cash flow is consistently negative, it means the company is not generating enough money from its core business and needs to finance itself with debt or equity.

Simple example: Imagine a coffee shop. Its operating cash flow comes from the money it receives from selling coffee, minus what it pays for beans, salaries, and rent.

b) Cash flow from investing activities (CFI)

This portion reflects the money the company spends or receives when investing in long-term assets: buying or selling machinery, opening new plants, acquiring other companies, or selling property.

Generally, this cash flow is negative in growing companies because they are investing for the future. However, if the cash flow is very negative for many years, it may be a sign that the company needs to invest excessively to maintain its business, which limits free cash generation.

Example: If the coffee shop buys a new espresso machine, that will appear as a negative investment flow.

c) Cash flow from financing activities (CFF)

This reflects the monetary movements related to shareholders and creditors: issuance or repurchase of shares, payment of dividends, issuance or payment of debt, etc.

A negative cash flow can be a good sign if it indicates the company is returning money to investors (for example, by paying dividends or repurchasing shares). On the other hand, a positive cash flow may mean the company is borrowing or issuing shares to raise cash.

Example: The coffee shop takes out a bank loan to open a new branch. That money comes in as a cash flow.

3. What is free cash flow and how is it calculated?

Free Cash Flow (FCF) is probably one of the most valuable metrics for investors. It represents the money a company has left after paying all its operating costs and the investments necessary to maintain its business.

In simple terms:

Free cash = Operating cash flow – Capital expenditures (CapEx)

CapEx (Capital Expenditures) refers to the money a company spends on fixed assets, such as machinery, technology, or infrastructure.

FCF tells you how much real money the company is generating that could be used for:

• Pay dividends

• Buy back shares

• Reduce debt

• Or simply accumulate liquidity for future opportunities

If a company has a high operating cash flow but also high CapEx, it may actually have little free cash left.

Practical example: Suppose a company generates $100 million of operating cash flow per year, but spends $60 million on new plants and equipment. Then: FCF = 100 - 60 = 40 million.

That means you actually have $40 million free at the end of the year.

4. How to detect if a company really generates free cash

Here's a simple step-by-step guide:

Step 1: Find the operating cash flow (CFO)

You'll find it in the cash flow statement, usually in the first section. Look for positive and consistent results. A solid company should generate cash on a recurring basis, not just in isolated years.

Step 2: Look at the investments (CFI)

Identify how much the company is spending on CapEx. If it's investing large sums, review whether those investments are generating growth or simply replacing old assets.

Step 3: Calculate free cash flow (FCF = CFO – CapEx)

This is the key metric. A positive and growing FCF over time is a sign of an efficient company that generates real money and isn't dependent on external financing.

Step 4: Review how you use your money (CFF)

A company that generates free cash can return capital to shareholders or reduce debt. If you see it constantly needing to issue stock or borrow money to stay afloat, that's a red flag.

5. Simplified real example

Imagine a technology company with the following annual cash flow (in millions of USD):

Concept	Amount
Operating cash flow	+120
CapEx (expenditure on assets)	-40
Total investment flow	-50
Financing flow	-30

Analysis:

• The positive operating flow of 120 million indicates that the company generates good money from its core business.

• Your investment (CapEx of 40) is reasonable, so the Free Cash Flow is 80 million (120 - 40) .

• In addition, its cash flow is negative because it is paying dividends or debt, which is healthy.

• Overall, the company creates value and does not rely on loans to operate.

If this pattern is repeated over several years, we are looking at a company with excellent cash management.

6. Warning signs to watch out for

Not all companies that report profits are financially sound. Here are some red flags you can spot in cash flow:

1. Constantly negative operating cash flow: This means the company isn't generating any money from its operations. Sooner or later, it will need debt or equity to survive.

2. Increased revenue without an increase in operating cash flow: This may indicate that sales are growing “on credit” or that customers are taking longer to pay.

3. Excessive CapEx: If the company spends too much on assets just to maintain its current sales level, its free cash flow will be reduced.

4. Dependence on external financing: If positive flows come from issuing equity or debt, rather than from operations, the sustainability of the business is in doubt.

5. Discrepancy between net income and operating cash flow: A large difference may indicate accounting problems, earnings manipulation, or poor earnings quality.

   
   

7. What does it mean to have a healthy free box?

A company with ample free cash flow can freely decide its future. It has options: It can grow, invest, distribute dividends, or buy back shares without jeopardizing its financial stability.

On the other hand, a company without free cash flow lives from day to day. It depends on the goodwill of banks or the markets to continue operating.

For investors, positive and growing Free Cash Flow is one of the best signs of strength. It's proof that the business is performing not only on paper but also in reality.

8. Conclusion: Cash flow, your best ally as an investor

Learning how to read cash flow statements is one of the most valuable skills an investor can develop. You don't need to be an accountant or a financial expert; just understand the logic behind the numbers.

In summary:

• Operating cash flow tells you whether the business is making money.

• The investment flow shows what you use it for.

• The financing flow reveals how the company is financed and what is returned to shareholders.

• And free cash is the final result: The money that is actually available.

If you learn to identify companies that consistently generate free cash flow, you'll be one step ahead of the market average. Because, in the end, a company's true profitability isn't measured by promises or accounting profits, but by its ability to convert those profits into real cash .