Free Cash Flow — the Only Money That Counts

Profit vs cash

Net income is an OPINION (accruals, estimates, recognition rules). Free cash flow = operating cash flow − capital expenditure — is a FACT: money actually generated after keeping the business running. A company can report profits for years while burning cash (receivables ballooning, inventory piling) — and it eventually runs out of other people's money. Cash flow is the lie detector for the income statement.

The FCF conversion test

Healthy businesses convert 80–100%+ of net income to FCF over a cycle. Persistent conversion below ~60% means earnings are lower quality: investigate working capital (receivables/inventory growing faster than sales = channel stuffing risk) and the gap between "adjusted EPS" and cash.

Capex character

Distinguish MAINTENANCE capex (keeping the machine running — a real cost) from GROWTH capex (building new capacity — an investment). FCF after maintenance capex is the true owner earnings Buffett talks about. A company claiming huge FCF while under-maintaining its assets is borrowing from its own future.

Sources

• Free Cash FlowInvestopedia
• Owner Earnings (1986 letter)Warren Buffett