Cash flow statement is a more reliable source than balance sheet and P/L. Businesses pay all its bills and expenses using its positive cash flow. Whatever left for growth and value is free cash flow (FCF).
Let’s me explain FCF using an example Company X.
How to calculate the final FCF?
For Company X, free cash flow would be RM 90,000 even though net income reported to shareholders was RM 40,000. The company use RM 90,000 to grow its company further.
Let’s repeat the last operation.
Again, we deduct another RM 50,000 for depreciation; Taxable income RM 47000. Tax is (RM 47000 x 20% = RM 9400). Net income is RM 37600; free cash flow is RM 87,600
Why did the net profit decrease? The company did not generate enough cash to maintain and grow its earnings. Do you check how much FCF your company is making? My point is, without increasing FCF, a business cannot survive for long. It must keep on depending on borrowings to fund growth.
If Company X makes a Revenue of RM 600,000 due to market monopoly and branding, it will not need to borrow to fund its growth anymore. Remember,growth needs money. And Cash is King.