Owner earnings are the cash a business actually generates for its owners after paying for everything needed to keep the operation running at its current level. Warren Buffett introduced the concept in his 1986 Berkshire Hathaway shareholder letter as a way around the accounting distortions in reported net income. The formula is simple to state and harder to apply: start with net income, add back non-cash charges like depreciation, then subtract the capital spending and working capital the business needs just to stand still.1Berkshire Hathaway. Chairman’s Letter – 1986
Net income tells you what accountants say the business earned. Owner earnings tell you what the business could hand to its owner without shrinking.
The Formula
Buffett defined owner earnings as reported earnings plus depreciation, depletion, amortization, and certain other non-cash charges, less the average annual capitalized expenditures for plant and equipment the business requires to fully maintain its long-term competitive position and its unit volume. He added that any incremental working capital needed to hold that competitive position should also come out.1Berkshire Hathaway. Chairman’s Letter – 1986
Written as an equation:
Owner Earnings = Net Income + Depreciation, Amortization, Depletion, and Other Non-Cash Charges − Maintenance Capital Expenditures − Incremental Working Capital
Each term deserves a closer look, because two of them are pulled straight from the financial statements and two require judgment.
The Four Inputs
Net Income
Net income sits on the bottom line of the income statement, sometimes labeled the Consolidated Statement of Operations in a 10-K. It’s revenue minus every recognized expense: cost of goods sold, operating costs, interest, and taxes. It’s the number most people call “profit,” and it’s the starting point precisely because it needs correcting.
Non-Cash Charges
The next step adds back expenses that reduced reported profit without any cash leaving the business. Depreciation is usually the largest. A company that buys a $500,000 machine expected to last ten years doesn’t book the full cost in year one; it spreads $50,000 across each of the next ten income statements. That $50,000 depresses reported earnings every year, but the cash actually left when the machine was purchased. Amortization does the same job for intangibles like patents, licenses, and acquired customer relationships. Depletion applies to natural resources such as oil reserves or timber.
You’ll find the specific numbers in the operating activities section of the cash flow statement. Under the indirect method, companies reconcile net income to cash from operations by adding these items back, so the figures are laid out for you.
Maintenance Capital Expenditures
This is where the calculation gets hard, and where most of the analytical work lives. Maintenance capital expenditures are the funds a business must spend to keep existing operations at their current level: replacing aging trucks, refurbishing restaurant locations, overhauling production equipment. Without this spending, the business slowly deteriorates.
Growth capital expenditures are different. They expand the business through new factories, new markets, or acquisitions. Buffett’s formula subtracts only maintenance spending because growth spending is discretionary. The problem is that neither U.S. GAAP nor IFRS requires companies to separate the two on their financial statements. The cash flow statement typically shows one line for capital expenditures that lumps everything together.
Three approaches are common for estimating the maintenance portion:
- Use depreciation as a proxy. Depreciation roughly reflects the annual wearing-out of existing assets, so it’s a reasonable stand-in for maintenance spending. This works for mature, stable businesses but understates the real cost when a company’s assets are old and fully depreciated but still due for replacement.
- Read management’s commentary. The Management’s Discussion and Analysis section of a 10-K often discusses capital spending plans, sometimes splitting sustaining from growth investment. The SEC requires registrants to discuss material commitments for capital expenditures and how they’ll be funded.2U.S. Securities and Exchange Commission. Financial Reporting Manual – Topic 9
- Look at history. Capital spending over five to ten years, compared against revenue trends, can show the baseline needed to hold revenue steady versus the extra spending that produced growth.
Getting this number wrong is the single biggest source of error in an owner earnings calculation. Overestimate maintenance spending and you’ll undervalue the business. Underestimate it and you’ll credit the company with discretionary cash it doesn’t actually have.
Incremental Working Capital
Working capital is the difference between current assets (cash, inventory, accounts receivable) and current liabilities (accounts payable, short-term debt). If a business structurally needs more working capital year after year just to keep operating at the same scale, that cash is trapped inside the business and unavailable to the owner. A retailer forced to carry progressively larger inventory for the same customer base has cash sitting in a warehouse instead of in the owner’s pocket.
Buffett noted that businesses using the LIFO inventory method usually don’t require additional working capital if unit volume stays constant, because LIFO naturally adjusts for rising input costs.
Not every working capital change needs an adjustment. Seasonal swings and one-time shifts don’t represent a permanent drain. The question is whether the business structurally requires more working capital each year to stay in place. If it does, subtract that amount. If working capital needs are stable, this term can be left out.
A Worked Example
Assume a company reports:
- Net income of $10 million
- Depreciation and amortization of $3 million
- Total capital expenditures of $5 million, of which you estimate $2.5 million is maintenance
- A $500,000 increase in working capital tied to maintaining current operations
The calculation: $10M + $3M − $2.5M − $0.5M = $10 million in owner earnings.
Reported net income and owner earnings happen to match here, but that’s coincidence. The $3 million depreciation add-back was nearly canceled by the $2.5 million in maintenance spending and $500,000 in working capital. Real companies rarely line up so neatly, and the two figures usually diverge in one direction or the other.
Run this over three to five years, not one. A single year can be distorted by unusual items, deferred maintenance, or one-time charges. What you’re looking for is the trend: whether the business generates a stable or growing stream of discretionary cash, or whether that stream is drying up.
How Owner Earnings Differ From Free Cash Flow
Free cash flow and owner earnings are close relatives that answer slightly different questions. Standard free cash flow takes cash from operations and subtracts total capital expenditures, both maintenance and growth. Owner earnings subtract only the maintenance portion.
That distinction matters. A company pouring money into expansion will show depressed free cash flow even when the core business throws off enormous discretionary cash. Owner earnings strip out the optional growth spending and ask what an owner could take home if the business simply maintained itself. Free cash flow asks what’s left after the company has spent on everything it chose to.
Neither is universally better. Free cash flow is easier to calculate because you don’t need to split capital expenditures, and it’s less exposed to analytical bias since the total is reported directly. Owner earnings require more judgment but give a cleaner view of the underlying cash engine. Investors evaluating a company in heavy growth mode often find owner earnings more useful; those focused on near-term cash for dividends or debt repayment tend to prefer free cash flow.
Stock-Based Compensation
Buffett wrote his formula in 1986, before stock-based compensation became a major component of corporate pay. Technology companies in particular now pay a significant share of employee compensation in stock options or restricted share units. These awards appear as a non-cash expense on the income statement and get added back in the operating activities section of the cash flow statement, in the same category as depreciation.
The question is whether to add stock-based compensation back the way you add back depreciation. Mechanically, no cash left the company when those shares were granted. Economically, every share issued dilutes existing owners. A company that issues $200 million in stock compensation and then spends $200 million on buybacks to offset dilution hasn’t saved anything; the buyback is a cash labor cost dressed up as capital allocation.
For businesses with material stock-based compensation, the conservative approach is to treat it as a real expense and not add it back. If you do add it back, at minimum track diluted share count over time. A rising share count means owners are paying for those grants through ownership erosion even when no cash changed hands.
Where to Find the Numbers
For public companies, the SEC’s EDGAR database gives free access to every required filing. Search by company name or ticker to pull up the 10-K annual report.3U.S. Securities and Exchange Commission. Search Filings The operating activities section of the cash flow statement supplies depreciation, amortization, stock-based compensation, and working capital changes. The investing activities section shows total capital expenditures. The MD&A section is where to look for clues about the maintenance-versus-growth split.
For private companies, you’ll work from internal financial statements, tax returns, and direct conversations with owners or management. The same framework applies, but data quality is lower and the adjustments larger. Private financials typically need normalization for above-market owner compensation, personal expenses run through the business, and related-party transactions priced off market.
Where the Metric Falls Short
The biggest limitation is the subjectivity in the maintenance capital expenditure estimate. Two competent analysts looking at the same company can produce materially different owner earnings figures depending on their assumptions about what spending is truly necessary. Companies rarely disclose the breakdown, and depreciation as a proxy only gets you close.
Owner earnings also don’t compare cleanly across industries. A software company with almost no physical assets shows very different dynamics than a utility or airline, where maintenance spending dominates the capital budget. Comparing owner earnings across sectors without adjusting for these structural differences can mislead you about which business is the better cash generator.
The metric works best for stable, mature businesses with predictable capital needs and limited working capital volatility. For early-stage companies, businesses in rapid transformation, or capital-intensive industries with lumpy replacement cycles, a single year’s number can be wildly unrepresentative. Calculate over multiple years, and pair it with other measures rather than leaning on it alone.