When a company reports high revenue and profits, it’s easy to feel confident. Headlines celebrate the numbers, and investors cheer. But profits on paper don’t always mean money in the bank. A company can look healthy while silently struggling to generate cash.
This is where cash flow becomes critical. To understand the real health of a business, we need to look beyond profit and see how much cash the company is actually generating from its operations.
Why cash flow from operations matters
Cash flow from Operations (CFO) is the true measure of a company’s operational health. While revenue shows what the company sold, and profit shows the accounting earnings after expenses, CFO shows the actual money coming into the business that can pay salaries, suppliers, and fund growth.
In simple terms: profit is an opinion, but cash is a fact. By looking at CFO, we can see whether a company is truly self-sustaining or just reporting numbers that look good on paper.
When profits are high but CFO is negative
Once we understand CFO, it becomes clear why some profitable companies can still face trouble. High profits combined with negative cash flow often signal underlying issues. Some reasons this happens include:
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Customers haven’t paid yet, so profits are booked but cash hasn’t arrived.
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Inventory piling up, trapping money in unsold stock.
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Accounting adjustments, like asset revaluations or one-time gains, inflating profits without bringing in cash.
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Aggressive revenue recognition, recording sales before cash actually comes in.
A company in this situation may look healthy on paper, but in reality, it could struggle to pay suppliers, employees, or service debt.
How to spot the warning signs
Once we know what to look for, spotting the mismatch between profits and cash is straightforward:
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Compare net profit with CFO in the cash flow statement.
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Watch for years where profit is positive but CFO is negative.
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Check changes in receivables, payables, and inventory. Sudden jumps can indicate that cash is getting stuck.
By paying attention to these signals, we can avoid companies that are “profitable on paper” but weak in actual cash generation.
Sectors to keep in mind
Some sectors naturally show differences between profits and cash flow, and this isn’t always a red flag:
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Capital-intensive businesses like infrastructure, utilities, or real estate. Large upfront investments can temporarily reduce cash.
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High-growth tech or subscription models, where revenue recognition and investments in customer acquisition can make cash flow fluctuate.
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Cyclical or commodity businesses like metals or oil & gas, where working capital swings with prices or inventory.
For these sectors, we should focus on long-term trends rather than one-year mismatches.
The takeaway
While revenue and profit offer a view into a company’s performance, understanding its cash flow from operations provides a more complete picture. We encourage you to look beyond reported profits and consider whether a company is truly generating the cash it needs to sustain and grow. Before your next investment, ask yourself: Is this company truly cash-rich, or just profit-heavy on paper?
Your homework: Comment the names of five companies that appear profitable on paper but show signs of weak cash generation from operations. What warning signs did you spot?