IAS 7 — Statement of Cash Flows

The statement of cash flows explains how an entity generated and used cash and cash equivalents during the period. Because it strips out accruals, it is often the statement investors and lenders read first — it is much harder to flatter cash than profit. IAS 7 governs its preparation.

Cash and cash equivalents

The statement deals with movements in cash and cash equivalents. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and subject to an insignificant risk of changes in value — in practice, investments with a short maturity from the date of acquisition, commonly three months or less. Bank overdrafts that are repayable on demand and form an integral part of cash management are included in cash and cash equivalents rather than shown as financing.

The three classifications

IAS 7.10 requires cash flows to be classified into three activities:

• Operating activities — the principal revenue-producing activities and other activities that are not investing or financing. Cash receipts from customers, payments to suppliers and employees, and cash flows relating to taxation (unless specifically identified with investing or financing) sit here.
• Investing activities — the acquisition and disposal of long-term assets and other investments not included in cash equivalents: purchases and sales of property, plant and equipment, intangibles, and equity or debt instruments of other entities.
• Financing activities — changes in the size and composition of contributed equity and borrowings: proceeds from issuing shares or loans, repayments of borrowings, and payments of lease liabilities (the principal element under IFRS 16).

IAS 7 gives policy choices for interest and dividends. Interest and dividends received and paid must each be classified consistently from period to period. Interest paid, for example, may be presented as operating or as financing; dividends paid may be financing or operating. Whatever is chosen, disclose it and apply it consistently.

Direct versus indirect method

IAS 7.18 allows operating cash flows to be reported using either method:

• the direct method discloses major classes of gross cash receipts and gross cash payments (cash from customers, cash paid to suppliers and employees, and so on). The IASB encourages it because it is more informative, but few entities use it in practice;
• the indirect method starts from profit or loss and adjusts for non-cash items (depreciation, amortisation, impairments, provisions), for items classified as investing or financing (such as gains on disposal and interest), and for movements in working capital (inventories, receivables and payables).

Investing and financing cash flows are reported the same way under both methods — as gross receipts and payments. Only the operating section differs.

A worked mini-example (indirect method)

Suppose an entity reports profit before tax of 500. It charged depreciation of 120 and recorded a gain of 20 on selling a machine. Over the year, inventories rose by 40, trade receivables fell by 15, and trade payables rose by 25. It paid interest of 30 and income tax of 90.

Gross versus net, and non-cash transactions

Cash flows are generally reported gross — you do not net purchases against sales of similar assets — although certain items with quick turnover, large amounts and short maturities may be reported net. Importantly, non-cash transactions (such as acquiring an asset under a lease, or converting debt to equity) are excluded from the statement itself and disclosed separately, because no cash moved.

Reconciliation of liabilities from financing activities

IAS 7 requires disclosures that let users evaluate changes in liabilities arising from financing activities — including both cash flows and non-cash changes such as foreign-exchange movements, fair-value changes and new lease liabilities. In practice this is presented as a "net debt" reconciliation, bridging opening to closing borrowings and lease liabilities.

Foreign currency and consolidated cash flows

Cash flows in a foreign currency are translated into the functional currency at the exchange rate at the date of the cash flow — a weighted average rate for the period may be used where it approximates the actual rates. Exchange gains and losses are not themselves cash flows, but the effect of exchange rate changes on cash and cash equivalents held in foreign currencies is reported separately in the statement, as a reconciling item, so that opening and closing cash still agree.

For a group, the statement presents the cash flows of the economic entity as a whole: intra-group cash flows are eliminated, and the aggregate cash flows from obtaining or losing control of subsidiaries are presented separately within investing activities, net of any cash and cash equivalents acquired or disposed of. This lets a reader see how much cash an acquisition actually consumed.

How it connects

The cash-flow statement is one of the five primary statements required by IAS 1. Its financing section is where lease payments appear, so it pairs closely with IFRS 16 leases, and its disclosures feed the notes.