There is a saying among the investor community, “Revenue is vanity, profit is sanity, cash is reality.”
Everyone who has seen enough market cycles knows that the third part of that sentence is the one that actually keeps companies alive.
And yet, every quarter, most investors open an earnings report and go straight to net profit. Up 20%? Great story. Down 10%? Panic. Very few scroll to the page where the cash flow statement quietly sits.
A Juice Company With No Juice
In 2016, a portfolio manager named Amit Mantri published a note flagging something odd about Manpasand Beverages, a fruit drink company that was, at the time, a darling of the mid-cap market.
But Mantri noticed one thing: cash flow from operations kept lagging behind reported profits. Not by a little. Consistently, year after year. The company was claiming to make money, but the cash wasn’t showing up where it should.
Three years later, the auditor Deloitte, after eight years of signing off on the books, abruptly resigned mid-year, which was one of the biggest red flags.
The MD and CFO were soon arrested. A forensic audit revealed that Manpasand had created 38 shell companies to run fictitious transactions through paper firms it had itself set up, faking its own sales and purchases in a loop.
The warning sign was visible in 2016. The stock peaked in 2018. All investors who read and understood the cash flow statements well had a two-year head start.
How the Cash Flow Statement Works
A cash flow statement has three buckets:
- Operating: money generated from day-to-day business
- Investing: money spent on or earned from assets and acquisitions (includes capital expenditure)
- Financing: money raised or repaid through loans and equity
Investors care most about operating cash flow. It tells you whether the core business is generating real money.
The Red Flags Worth Knowing
Profits Growing, Cash Not Following
This is the most reliable signal. A healthy business converts most of its profit into cash over time. If profits keep growing but operating cash flow stays flat or falls, with no clear reason like a major expansion, something is worth investigating.
Receivables Growing Faster Than Sales
This is in a way linked to the first one. If revenue is rising but customers are taking longer to pay, that is a problem. It usually means sales are being pushed onto distributors who have not actually sold through yet, or in extreme cases, the sales are not real at all.
Supplier Payments being stretched
This one is very common. If a company holds back payments to vendors before the reporting period ends, its operating cash flow looks healthier than it actually is. If you notice a significant and sudden increase in accounts payable on the balance sheet, that’s your cue to dig deeper.
Shell Entity Shuffling
Like Manpasand, Enron, a US company famous for its accounting scam, created over 3,000 special purpose vehicles (shell companies). It sold assets to them, and booked the proceeds as operating income.
Operating Cash Flow Is Not the Full Picture Either
Even investors who track operating cash flow often stop there. They should not.
Businesses need to spend money on equipment, factories, and technology just to stay operational. Operating cash flow tells you what the business generated. It does not tell you what was left after maintaining and growing it.
The number that does is Free Cash Flow:
Free Cash Flow = Operating Cash Flow − Capital Expenditure
Consider an airline. IndiGo generates healthy operating cash flow. But aircraft, maintenance, and leases are expensive. Subtract that capex and the picture looks very different.
Now consider HDFC AMC. Minimal physical infrastructure, low reinvestment needs. Most of what it generates flows through as free cash.
That is why asset-light businesses tend to trade at higher valuations, the market is pricing in exactly this. When analysts say a stock is “expensive on earnings but cheap on free cash flow”, this is the comparison they are making.
(The companies mentioned above are just examples and are not recommendations)
There Is a Small Catch
Under SEBI rules, companies must publish quarterly results: revenue, profit, margins. But the Balance Sheet and the Cash Flow statement is required to be published only half yearly.
Profit numbers update every quarter. Cash flow data can lag by six months. And that delay is exactly why most investors stop paying attention to it.
The Final Word
To become a better investor, one should always compare net profit to operating cash flow, every year, for at least five to ten years.
A healthy business converts most of its profit into cash over time. If profits are growing but operating cash flow is flat or falling, with no obvious capital-heavy reason, that gap is a question worth asking.
The income statement tells you the story management wants you to hear. The cash flow statement tells you what actually happened. And that’s why it deserves more respect than it gets.
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Till the next time,
Vijay
CEO – InCred Money
