Why profit and cash diverge
Recognising a sale does not necessarily mean the customer has paid. Credit sales create receivables; inventory purchases and expense recognition can occur at different times. Depreciation does not require a new cash payment in that period. Cash flow reveals these timing differences, allowing profitable companies to face cash shortages and low-profit businesses to report temporarily strong cash generation.
Three sections, three different questions
Operating cash shows cash generated by the business, investing cash covers asset purchases and disposals, and financing cash includes borrowing, capital, repayments and distributions. Identify which section caused cash to rise. New borrowing is different from customer collections. Negative investing cash is not automatically bad: capacity investment may support future revenue. Its purpose and funding matter.
Example: positive profit, weak free cash flow
Assume net income of TRY50 million, depreciation of TRY15 million and TRY40 million of working-capital cash use. With no other items in this simplified example, operating cash is TRY25 million. Capital expenditure of TRY30 million gives free cash flow of minus TRY5 million, using operating cash less capex. The business remains profitable but has not fully funded investment from operations during the period.
The trap of one-period analysis
Accelerating collections or delaying supplier payments can improve one period’s operating cash. Inventory build-up ahead of a season is not necessarily a lasting problem. Review several periods and interpret receivable, inventory and payable days through the business model. Cash conversion ratios become unstable when net income approaches zero; a universal threshold is inappropriate.
Define free cash flow explicitly
Free cash flow is not one universally defined accounting line. State the formula and treatment of leases and acquisitions. Do not mechanically apply an industrial-company measure to a bank. Reconcile opening cash, cash movements and FX effects with closing cash. Cash-flow analysis examines funding resilience; it does not provide a price target.
Sources and further reading
Numerical examples are illustrative scenarios, not company data, bank offers or current tax rates.
This content is general information and financial education. It is not personalized investment advice or a recommendation to buy or sell.