If you follow the profit and loss statement that listed companies release each quarter, you might get idea about gross profit margin, net profit margin, earnings growth, and the price/earnings (P/E) ratio, which are the fundamental indicators for stock analysis.

And yet there’s that old saying: Cash is king. Although the quarterly earnings-per-share (EPS) data grab most of the headlines each quarter, many analysts consider cash flow—a company’s cash inflows and outflows in a given period—to be the foundation of its financial health and a critical tool for deciding whether a stock might be worth investing or not.

The net cash (flow) generated by a company in a quarter or year is the ground reality. The net profit generated by a company in a quarter or year is an accounting miracle. Cash flow can bring out the true picture of a company’s financial health, making it different from profits, because cash flow doesn’t have any accounting assumptions or accruals. Companies that generate positive net cash flow quarter after quarter are likely to be in a good position to deliver ongoing earnings growth, to pay increased dividends and buyback shares.

A company’s cash flow statement is divided into three parts – (1) cash generated from the operating activities (2) cash generated from the financing activities (3) cash generated from the investing activities, and finally net increase or decrease in cash balance for the period.

If a company posts good net profit, but the cash generated from its operating activities is negative for the period, it indicates a worrying trend. Probably the company is accounting the revenue on accrual basis, without actually collecting money from its customers.

Cash generated from financing activities includes increase or decrease in bank loans and interest payments. If a company’s cash generated from financing activities is positive, it may not necessarily indicate a positive trend. It only indicates that the company is borrowing more money from banks to meet the cash deficit in its operating activities.

Cash generated from investing activities consists of capital expenditure spent by the company and investments made in the subsidiary companies.

If a positive cash flow trend begins to decelerate or decline, it can be a warning signal for investors. Be wary of a company that is reporting increased profits but decreased cash flow from operations during the same period.

And if a company isn’t producing enough cash flow from operations to cover items such as capital expenditures, debt payments, or dividends, it could mean the company has to borrow to meet these payments.

A steady downward trend in cash flow from operations could point to weak management. It might also indicate a poor use of assets and resources.