Six lines in a cash flow statement that tell you more than the earnings release

An adjusted earnings figure is a company’s argument about itself. The cash flow statement is closer to a record. Neither is truth, but one of them is much harder to compose. Here is the order I read things in, which has not changed in a decade.

1. Cash from operations against net income

Over any three-year window these should track. When operating cash flow persistently lags reported income, something in working capital is absorbing the difference and the next four lines tell you what.

2. Change in receivables against revenue growth

Receivables growing meaningfully faster than revenue for more than two quarters is either a genuine change in customer mix or revenue being recognised earlier than it is collected. Companies will tell you which if you ask; the pattern tells you whether to ask.

3. Change in inventories

Rising inventory in a business with falling volumes is the single most reliable early warning I know of in industrials. It shows up two or three quarters before the margin does.

4. Capitalised costs

Especially software development and, in some sectors, contract acquisition costs. Moving spend from the income statement to the balance sheet raises earnings without changing anything real, and the transition is visible as a step change in this line.

5. Stock compensation added back

It is a real cost. Whether or not you agree, at minimum look at it as a fraction of operating cash flow. Above fifteen per cent and the free cash flow number in the presentation is describing a different company than the one the shareholders own.

6. The financing section, in full

Buybacks net of issuance, not gross buybacks. A company repurchasing shares while issuing a similar amount to employees has not returned capital; it has run a payroll through the equity account.

What each line has actually caught, in my own notes

Line	Lead time	False positives
Receivables	2–3 quarters	High
Inventories	2–4 quarters	Moderate
Capitalised costs	1–2 quarters	Low
Net buyback	Immediate	Low

What I stopped doing

I used to run a composite score across all six and rank a universe by it. It backtested beautifully and worked poorly, for the usual reason: the signals that matter are the ones where you can read the footnote and form a view, and a rank column throws the footnote away.