Cash Flow vs Owner Earnings

Cash Flow

Net income after taxes + Depreciation + Depletion + Amortization + Other non-cash charges = Cash flow

Owner Earnings

Net income + Depreciation + Depletion + Amortization – Capital Expenditures – Other Working Capital = Owner Earnings

Cash Flow vs Owner Earnings

The problem with relying on cash flow figures is that they leave out a critical economic fact, capital expenditures.

How much of the year’s earnings must the company use for new equipment, plant upgrades, and other improvements needed to maintain its economic position and unit volume?

According to Buffett approximately 95% of American businesses require capital expenditures which are require roughly equal to their depreciation rates. If such (necessary) expenditures are ignored for a year or so, the business will surely decline. These capital expenditures are, therefore, as necessary to the business as utility and labor costs.