Microsoft
MSFT · NasdaqFree cash flow has fallen to half of net income
Capital spending of $39.4B took 67.9% of operating cash flow, leaving free cash flow of $18.6B, down from $25.7B, only 50.9% of net income.
Q1 FY2027, the quarter to Sep 30, 2026 (Microsoft's fiscal 2027 ends in June 2027) · 10-Q filed Oct 28, 2026
- Operating margin
- 49.8%
- Net income
- $36.6B
- Free cash flow, quarter
- $18.6B
Largest source of revenue: Azure, 35.9% of the total.
Where Microsoft's money goes
- 01
Free cash flow has fallen to half of net income
Capital spending of $39.4B took 67.9% of operating cash flow, leaving free cash flow of $18.6B, down from $25.7B, only 50.9% of net income.
Why it matters
Operating cash flow rose to $58.0B from $45.1B a year earlier, but capital expenditure roughly doubled to $39.4B from $19.4B. Capital spending used 67.9% of operating cash against 43.0% a year earlier, and free cash flow fell to $18.6B from $25.7B. Capital spending equalled 42.7% of revenue, against 25.0%.1
The shift has built over years. Seven years before the last fiscal year, free cash flow was $38.3B against net income of $39.2B, nearly all of it. Last fiscal year capital spending was $115.9B against operating cash flow of $182.9B, and free cash flow was $67.0B: about half of net income of $133.7B, and below the $74.1B of two years before.1
AnalysisRead as analysis: reported profit no longer describes the cash the business keeps. The gap is the data-center program, which turns today's cash into equipment that is expensed over many years through depreciation. Net income measures the earning power of the installed base; free cash flow shows how much of it is being reinvested.
Single quarters are a noisy read: free cash flow was $5.9B three quarters ago and $18.6B this quarter. The annual figures show the same direction as the quarter.1
- 02
Operating margin rose while gross margin fell
Cost of revenue grew 23.6% and gross margin slipped 1.25 points, yet operating costs grew slowly enough to lift operating margin 0.88 points to 49.8%.
Why it matters
Revenue grew 18.8% to $92.3B while cost of revenue grew 23.6% to $29.7B, so gross margin fell to 67.8% of revenue from 69.0% a year earlier. Gross margin in dollars rose 16.65%, slower than revenue.1
Below gross margin the costs moved the other way. Sales and marketing was $5.7B, the same as a year earlier, and fell to 6.2% of revenue from 7.4%. Research and development grew 11.1% to $9.0B and general and administrative 4.15% to $1.9B. Operating income rose 21.0% to $45.9B, faster than revenue.1
AnalysisRead as analysis: the two halves of the income statement tell different stories. Running the cloud costs more per dollar of revenue as new capacity enters cost of revenue, while selling it costs less, because new services are added to enterprise agreements Microsoft already holds. The filing text supplied here does not attribute either move, so the reasons are our reading.
Against the prior quarter, gross margin rose to 67.8% from 67.2%, after falling in each of the three quarters before that from 69.0% a year ago. The prior quarter is derived from annual and nine-month totals rather than reported on its own.1
- 03
Net income outgrew operating income on an investment swing
Net income rose 32.0% against 21.0% for operating income, because other income moved from a $3.66B net expense to $38 million.
Why it matters
A year earlier other income (expense), net was a net expense of $3.66B, equal to 9.6% of operating income. This quarter it was $38 million of income. Income before income taxes therefore rose 34.0% to $46.0B while operating income rose 21.0%. The tax provision rose 42.3% to $9.3B, 20.3% of pre-tax income against 19.1%, which narrowed but did not close the gap.1
The filing records impairments and changes in the fair value of investments in this line. It accounts for its stake in OpenAI by the equity method, recognising income or loss as the change in what it would receive if OpenAI's net assets were distributed at book value.1
The line moves a lot. Three quarters ago net income of $38.5B was larger than operating income of $38.3B.1
AnalysisRead as analysis: the 21.0% operating growth is the measure of the business; the extra growth in net income came from a line that can reverse. Comparing net income across quarters without separating that line can overstate or understate the trend.
Sources
- 1.Microsoft 10-Q for the period to 2026-09-30 (the filing), Oct 28, 2026, read Nov 2, 2026
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Growth, profit and margin
Revenue went from $60.4B in FY2008 to $331.8B in FY2026, the operating margin from 36.9% to 46.8%, over 18 years.
- Revenue$331.8B
- Operating income$155.2B
- Operating margin46.8%
- Period
- Q1 FY2027
- Revenue
- $92.3B
- Operating income
- $45.9B
- Operating margin
- 49.8%
- Net income
- $36.6B
- Free cash flow
- $18.6B
Does the profit turn into cash?
Q1 FY2027: free cash flow of $18.6B against net income of $36.6B in the quarter.
- Operating cash flow$182.9B
- Capital expenditure$115.9B
- Free cash flow$67.0B
- Net income$133.7B
Capital expenditure is drawn below the axis as cash out. Cash conversion is operating cash flow over net income, shown in the tooltip for years with a profit.
Financial data and sources
How the revenue mix has shifted
Each breakdown the filing reports, as shares of revenue, for every period it restates.
Revenue Classified by Significant Product and Service Offerings (Detail). The filing restates this breakdown for 1 period.
Click a member to isolate it across the years shown.
The figures
Margins, cash and growth for the period, each with what it was computed from.
Where revenue comes from
Every breakdown the filing reports for the period, with each item's share.
Revenue streams
| Azure | $33.2B | 35.9% |
| Microsoft 365 cloud | $27.8B | 30.1% |
| Productivity and server licensing | $8.4B | 9.1% |
| Search and advertising | $6.6B | 7.1% |
| Xbox | $5.4B | 5.8% |
| Industry solutions | $5.3B | 5.8% |
| Windows OEM and devices | $3.6B | 3.8% |
| Frontier and support services | $2.1B | 2.3% |
Segments
| Agents and Infra | $76.8B | 83.2% |
| Devices and Consumer | $15.5B | 16.8% |
What it costs
The cost lines beneath operating income, each as a share of revenue, then the operating result.
Costs are reported by function: what it cost to make what was sold, then the expenses of selling, developing and administering.
| Cost line | Q1 FY2027 | Of revenue | Source |
|---|---|---|---|
| Cost of revenue | $29.7B | 32.2% | Source10-Q, us-gaap:CostOfGoodsAndServicesSold, as reported in the 10-Q filed 2026-10-28 |
| Operating income | $45.9B | 49.8% | Source10-Q, us-gaap:OperatingIncomeLoss, as reported in the 10-Q filed 2026-10-28 |
Operating income by segment
Where the operating profit is earned, as the filing reports it.
Segments
| Agents and Infra | $40.6B | 88.3% |
| Devices and Consumer | $5.4B | 11.7% |
Shares of operating income. Source10-Q, us-gaap:OperatingIncomeLoss, as reported in the 10-Q filed 2026-10-28
The statements, as filed
The income statement, cash flow statement and balance sheet in the company's own order and words. Every line links to the filing.
Income statement19 lines, as presented in the 10-Q
Cash flow statement32 lines, as presented in the 10-Q
Year to date, as a quarterly filing reports it.
Balance sheet33 lines, as presented in the 10-Q
About this data
- Source
- Microsoft 10-Q, accession 0001193125-26-436133, filed Oct 28, 2026, read on Nov 2, 2026.
- History
- From the SEC's XBRL company facts, the value from the latest filing that stated each period.
- Reading
- Paragraphs marked Analysis are CXProWealth's reading; everything else is the filing's own numbers and words, or a cited source.
- Version
- methodology business-lens-1.0 · schema 1.2.0 · run business-lens-2026-11-02
What holds Microsoft's model up, and what could bend it
Competitive edge
Subscriptions are replacing one-time licenses
Office cloud subscriptions grew 17.2% to $27.8B while licensing sold outside the cloud fell 3.1% to $8.4B, so more revenue now renews by default.
The detail
Productivity and server licensing, software sold outside the cloud, fell 3.1% to $8.4B and lost 2.06 points of revenue share. Cloud subscriptions to the Office suite and related apps grew 17.2% to $27.8B, 30.1% of revenue.1
AnalysisRead as analysis: a perpetual license pays once and reopens the buying decision at each upgrade; a subscription renews unless the customer acts, and lets Microsoft add features and adjust price inside the same relationship. The shrinking line is the cost of that trade, and the renewing line is why it holds.
The enterprise segment earns a 52.8% operating margin
Agents and Infra brought 83.2% of revenue but 88.3% of operating income, at a 52.8% margin against 34.6% for Devices and Consumer.
The detail
Agents and Infra had $76.8B of revenue and $40.6B of operating income. Devices and Consumer had $15.5B of revenue and $5.4B of operating income. The enterprise and cloud side is the larger business and also the more profitable one per dollar of revenue.1
AnalysisRead as analysis: enterprise software and cloud are bought on multi-year agreements, sit inside daily work and are costly to switch away from, which supports pricing. Consumer devices and gaming compete on hardware and content cycles, where margins are thinner.
Operating cash still pays for the build
Operating cash flow of $58.0B covered capital spending of $39.4B with $18.6B left over, so the build is paid for with cash the business generates.
The detail
Operating cash flow was 1.58 times net income this quarter, $58.0B against $36.6B. Capital spending used 67.9% of it, against 43.0% a year earlier. Last fiscal year operating cash flow of $182.9B covered capital spending of $115.9B and left $67.0B of free cash flow.1
AnalysisRead as analysis: few companies can spend at this scale out of operating cash. The established software lines, with operating margins near half of revenue, fund capacity whose return arrives over many years. The cover has narrowed, though, because spending is growing faster than cash from operations.
What to watch
New capacity has to fill at prices that hold
Capital spending reached 42.7% of revenue this quarter, and last fiscal year's $115.9B compared with $44.5B two years earlier; the return depends on paying use.
The detail
Capital spending rose in every quarter of the past year, from $19.4B to $39.4B. Last fiscal year it was $115.9B, against $64.6B the year before and $44.5B two years before. Cost of revenue grew 23.6% against revenue's 18.8% this quarter, and gross margin fell 1.25 points to 67.8%.1
AnalysisRead as analysis: equipment bought now is depreciated through cost of revenue for years. If demand fills the new capacity at prices that hold, gross margin settles; if it fills more slowly or at lower prices, gross margin keeps slipping while the spending is already committed.
One partner sits in revenue, receivables and investments
OpenAI is a customer, a revenue-sharing partner and an equity-method investee, so its financing and growth reach Microsoft's revenue and other income at once.
The detail
The filing describes a long-term strategic partnership with OpenAI, discloses it as a related party, and reports revenue from commercial arrangements with it, inclusive of revenue-sharing payments, and accounts receivable from it. The stake is accounted for by the equity method, measured by hypothetical liquidation at book value.1
On investments generally, the filing calls the impairment judgment significant and states: "If market, industry, and/or investee conditions deteriorate, we may incur future impairments."1
AnalysisRead as analysis: the same relationship can lift cloud revenue and the investment line together, and could weigh on both together. The disclosed revenue and receivables from OpenAI, filing to filing, show whether that dependence is growing faster than the rest of the cloud.
AI agents widen the cyber attack surface
The filing says nation-state attacks have increased and that AI and cybersecurity risks increasingly overlap and amplify one another, inside the company as well as outside.
The detail
The risk factors say attackers use AI to automate reconnaissance, find vulnerabilities faster and iterate on attacks, reducing the time Microsoft has to respond, and that nation-state attacks on it and its customers, suppliers and partners have increased.1
Internally, AI models and agents with access to infrastructure or sensitive data "may present risks similar to those associated with highly privileged users or threat actors." The filing also names lapses such as passwords not rotated and employee access not removed on time.1
AnalysisRead as analysis: cloud contracts rest on trust. A serious incident would show first as remediation cost, outages or slower renewals in the lines that now carry most of the profit, before it shows in the income statement.
Sources
- 1.Microsoft 10-Q for the period to 2026-09-30 (the filing), Oct 28, 2026, read Nov 2, 2026
Microsoft, further in
Member research, then your own questions on ChatGPT.
What could change the outlook
What Microsoft's numbers depend on from here, read from the filing: the conditions behind this period's margins and growth, and where a change would show first.
- What free cash flow depends on from here
The figures that decide whether cash catches up with profit: where capital spending levels off, what gross margin does as capacity comes online, and what to watch in each filing.
- How much of the cloud's growth rests on one partner
How the OpenAI relationship runs through revenue, receivables and the investment line, and which disclosures show whether that dependence is growing or contained.
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Have a question about Microsoft?
Explore its profit drivers, competitive edge, risks, or your own investment and business questions with CXProWealth on ChatGPT.
- Why did Microsoft's operating margin rise this quarter while its gross margin fell?
- What would it take for Microsoft's free cash flow to climb back toward its net income?
- How does OpenAI show up in Microsoft's revenue, receivables and other income?
Business Lens describes Microsoft from its own filings with the SEC. It is not a view on its shares, a target, or advice to buy, sell or hold anything; figures are as filed and may be restated by the company later. The filing, the dates and the version are under the financial data above.