The 3 statements · 3

The cash flow statement

Profit and cash are not the same thing. A company can report a profit and still run out of money. The cash flow statement tracks every real dollar that came in or went out during the year, in three buckets.

👴 In one sentence It's your bank statement, sorted into: money from your job, money spent on big purchases, and money borrowed, repaid or given away.

1. Operating

Cash from the everyday business: selling bread, paying suppliers and staff.

2. Investing

Buying (or selling) long-term things: ovens, buildings, other companies.

3. Financing

Dealing with the money providers: loans taken or repaid, dividends, share buybacks.

Rat Bakery's cash flow statement

Rat Bakery Ltd. — Cash flow statement Year 2025 · in $
Net income72,000
We start from the profit on the income statement…
+ Depreciation30,000
…and add back depreciation, because it was a cost on paper but no cash left this year.
Increase in receivables(5,000)
Cafés owe us $5,000 more than last year: counted as sales, but the cash isn't here yet.
Increase in inventory(3,000)
We bought extra flour. Cash out, but not a cost until it's baked and sold.
Increase in payables4,000
We owe the miller $4,000 more: cash we haven't paid out yet.
Cash from operations98,000
Operating cash flow (OCF): the cash the business really generated. Higher than profit here — a good sign.
Purchase of a new oven(40,000)
Capital expenditure (capex): spending on long-term assets. Not an expense on the income statement — it's depreciated over the years.
Cash from investing(40,000)
Usually negative for a healthy company: it's investing in its future.
Bank loan repaid(15,000)
Repaying debt is a financing activity (the interest was already in net income).
Dividends paid(28,800)
40% of net income paid to the owners. The other 60% stays in the business.
Cash from financing(43,800)
Money returned to lenders and owners.
Net change in cash14,200
98,000 − 40,000 − 43,800. Cash grew from $45,800 to $60,000 — exactly the cash on the balance sheet. ✅

Free cash flow: the number investors love

Free cash flow (FCF) is the cash left after the business has paid for everything it needs to keep running and growing. It is the money that could be paid to owners, used to repay debt, or saved — without harming the business.

Free cash flow = Cash from operations − Capital expenditure = 98,000 − 40,000 = 58,000

Rat Bakery turned $72,000 of profit into $58,000 of free cash. That ratio (FCF ÷ net income = 81%) is called cash conversion. Over many years, a healthy company's free cash flow should be close to its net income.

⚠️ Red flags in the cash flow statement
  • Net income keeps rising, but operating cash flow does not — profits may be "on paper" only.
  • Dividends larger than free cash flow, year after year — paid with borrowed money.
  • Capex consistently far below depreciation — the company may be under-investing and wearing out its assets.

The three statements together

StatementQuestion it answersRat Bakery's answer
Income statementDid we make a profit this year?Yes: $72,000 (14.4% of sales)
Balance sheetWhat do we own and owe today?Own $300,000, owe $125,000, equity $175,000
Cash flow statementWhere did the cash come from and go?Generated $98,000, invested $40,000, returned $43,800
✏️ Check yourself: a company reports a $1 million profit, but its receivables grew by $1.5 million. What was its operating cash flow (ignoring everything else)?
Show the answer

$1,000,000 − $1,500,000 = −$500,000. It "earned" a profit but customers haven't paid — it actually lost cash. This is exactly why we read all three statements.