Article
Companies report earnings using accrual accounting, which recognizes revenue when earned and expenses when incurred—regardless of when cash actually changes hands. This is useful for understanding economic activity, but it can mask cash problems.
A company might report high earnings while burning cash. Conversely, a company might report modest earnings while generating significant cash. Which is the true picture? Cash never lies.
Free Cash Flow (FCF) = Operating Cash Flow - Capital Expenditures. It represents cash available after the company pays for equipment, facilities, and other investments needed to maintain and grow the business.
FCF is what really matters. Earnings can be manipulated through accounting choices. FCF is harder to fake. A company consistently generating strong FCF can return money to shareholders through dividends and buybacks, or reinvest in growth.
The ultimate value of any business is the cash it can generate over its lifetime. A company with growing FCF is becoming more valuable. A company with declining FCF is in trouble, regardless of what the earnings report says.
Compare FCF to net income. If FCF is consistently lower, ask why. Is the company investing heavily in growth? Or is it disguising cash problems through accounting? The answer matters.