Profit isn't cash. The cash flow statement explains how cash moved during the year, in three sections:
- Operations starts from net income and undoes the parts that weren't cash: add back non-cash costs such as depreciation and stock-based compensation, then adjust for working capital. A rise in receivables or inventory uses cash (negative); a rise in payables keeps cash in the business (positive). A fall in inventory releases cash, so it's positive.
- Investing: capital expenditures and acquisitions, usually negative.
- Financing: borrowing and repaying debt, dividends, share issues and buybacks.
The three add up to the net change in cash, and last year's cash plus that change must equal this year's cash on the balance sheet.
Free cash flow = cash from operations - capital expenditures. Cash conversion = free cash flow / net income shows how much of the profit turned into spendable cash.