Topic 4: Statement of Cash Flows
🟢 Lite — Quick Review (1h–1d)
IAS 7 — Statement of Cash Flows
Cash Flows split into three activities:
1. Operating Activities (Key — always required):
- Cash received from customers
- Cash paid to suppliers and employees
- Cash paid for inventories
- General operating cash flows
2. Investing Activities:
- Purchase/sale of PPE and intangibles
- Purchase/sale of investments
- Loans given/received
- Interest and dividends RECEIVED
3. Financing Activities:
- Proceeds from issuing shares/loans
- Repayment of borrowings
- Dividends PAID
- Lease payments (principal portion only — IFRS 16)
Methods:
- Direct: Major classes of gross cash receipts and payments (IAS 7.18)
- Indirect: PBT adjusted for non-cash items and working capital changes (IAS 7.20)
⚡ Exam tip: Interest paid is often classified as operating. In Pakistan/ACCA, dividends paid = financing. IAS 7 permits flexibility but interest paid/received has specific rules. ALWAYS check exam question for classification requirements.
🟡 Standard — Regular Study (2d–2mo)
IAS 7 — Statement of Cash Flows
The statement of cash flows explains how entity’s cash and cash equivalents changed during the period (opening → closing).
Cash and Cash Equivalents (IAS 7.6):
Cash = cash on hand + demand deposits Cash Equivalents = short-term, highly liquid investments with original maturity ≤3 months, readily convertible to known amounts, subject to insignificant risk of changes in value (e.g., treasury bills, money market funds).
Bank overdrafts are NOT cash equivalents — they are liabilities. They may be included in cash management in some jurisdictions but IAS 7 treats them separately.
Cash Flows from Operating Activities — Direct Method:
Cash received from customers XXX
Cash paid to suppliers (XXX)
Cash paid to employees (XXX)
Cash paid for other operating (XXX)
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Net cash from operating activities XXXCash Flows from Operating Activities — Indirect Method:
Profit before tax XXX
Adjustments for:
Depreciation and amortisation XXX
Loss/(Gain) on disposal of NCA XXX
Finance costs (interest) XXX
Decrease/(Increase) in inventories XXX
Decrease/(Increase) in receivables XXX
Increase/(Decrease) in payables XXX
-----
Cash generated from operations XXX
Tax paid (XXX)
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Net cash from operating activities XXXInvesting Activities — Common Items:
| Item | Classification |
|---|---|
| Purchase of PPE | Investing outflow |
| Proceeds from sale of PPE | Investing inflow |
| Purchase of financial instruments | Investing outflow |
| Proceeds from sale of financial instruments | Investing inflow |
| Interest received | Investing OR Operating (policy choice) |
| Dividends received | Investing OR Operating (policy choice) |
| Loans given | Investing outflow |
| Loan repayments received | Investing inflow |
Financing Activities — Common Items:
| Item | Classification |
|---|---|
| Proceeds from share issue | Financing inflow |
| Share buyback / redemption | Financing outflow |
| Proceeds from bank loan | Financing inflow |
| Repayment of bank loan | Financing outflow |
| Lease principal payments (IFRS 16) | Financing outflow |
| Dividends paid | Financing outflow |
| Interest paid | Financing OR Operating (policy choice) |
Key Formulas:
- Free Cash Flow to Firm (FCFF): NOPAT + D&A − ΔWC − Capex
- Cash Conversion Ratio: Operating Cash Flow / Net Profit (higher = better)
- Cash to Debt Ratio: Operating Cash Flow / Total Debt
⚡ Exam tip: The indirect method reconciles PBT to operating cash flow — you must show ALL working capital changes. A common trick: increase in inventory = cash outflow (subtract), increase in payables = cash inflow (add back).
🔴 Extended — Deep Study (3mo+)
Comprehensive Analysis — IAS 7 Statement of Cash Flows
Understanding the Cash Flow Statement’s Purpose:
The cash flow statement bridges the accrual-based P&L and SoFP to show actual cash movements. A profitable company can still fail due to poor cash management — the cash flow statement exposes this. IAS 7 requires all entities to present a cash flow statement.
Indirect Method — Detailed Derivation:
Start with PBT and work through:
Non-Cash Items to Add/Subtract:
- Depreciation (no cash outflow, add back)
- Amortisation of intangibles (add back)
- Amortisation of bond premium/discount (adjust finance cost)
- Impairment of assets (add back if loss, subtract if reversal)
- Loss/(Gain) on disposal of NCA (subtract gain, add loss)
- Unrealised foreign exchange losses/(gains) (add/subtract)
Working Capital Changes:
- Increase in inventories → cash OUTFLOW (money tied up)
- Decrease in inventories → cash INFLOW (money released)
- Increase in trade receivables → cash OUTFLOW (owed but not collected)
- Decrease in trade receivables → cash INFLOW (collected)
- Increase in trade payables → cash INFLOW (supplier financing)
- Decrease in trade payables → cash OUTFLOW (paid off)
Direct vs Indirect — Why Indirect is More Common:
Most entities use indirect because it’s easier to prepare from existing accounting records. The direct method ( IAS 7.18) requires tracking individual cash transactions — more useful for users but more burdensome to prepare. IAS 7 encourages but does not mandate the direct method.
Foreign Currency Cash Flows — IAS 7.25-28:
Translate foreign currency cash flows using exchange rates at dates of cash transactions. Effect of exchange rate changes on foreign cash balances is shown separately (not in operating, investing, or financing) — as “effect of exchange rate changes on cash.”
Non-Cash Transactions (IAS 7.43):
These are excluded from cash flow statement but disclosed in notes:
- Acquisition of assets through finance leases
- Conversion of debt to equity
- Asset exchanges (non-cash)
- Acquisition by issue of shares
- Dividend reinvestment plans
IFRS 16 and Cash Flows — Critical for ACCA:
Under IFRS 16, lease payments are split:
- Principal portion → Financing activities (outflow)
- Interest portion → Can be classified as Operating (preferred) or Financing
- Short-term lease payments / low-value leases → Operating activities
IFRS 16.59: “cash payments for the principal portion of lease liabilities are classified as financing activities.” This increased financing outflows significantly for lessees.
Worked Example — Indirect Method:
Pakistan Mills Ltd: PBT Rs.2,400,000; Depreciation Rs.480,000; Gain on sale of machine Rs.120,000; Increase in trade receivables Rs.200,000; Increase in inventories Rs.150,000; Increase in trade payables Rs.300,000; Tax paid Rs.600,000; Bonus shares issued Rs.500,000; Interim dividend paid Rs.400,000.
Cash Flows from Operating Activities:
PBT 2,400,000
Adjustments:
Depreciation 480,000
Gain on disposal (120,000)
Increase in trade receivables (200,000)
Increase in inventories (150,000)
Increase in trade payables 300,000
----------
Cash generated from operations 2,710,000
Tax paid (600,000)
----------
Net cash from operating activities 2,110,000
Cash Flows from Investing Activities:
Proceeds from sale of machine 200,000 (gain 120 means BV was 80)
Purchase of new equipment (800,000)
----------
Net cash used in investing (600,000)
Cash Flows from Financing Activities:
Dividends paid (400,000)
Proceeds from share issue 600,000
Repayment of long-term loan (300,000)
----------
Net cash used in financing (100,000)
Net increase in cash 1,410,000Common Exam Mistakes:
- Classifying interest paid as investing (it’s usually operating)
- Forgetting that bank overdraft is a current liability — changes in overdraft are cash flows
- Misclassifying bonus share issue (non-cash, disclosed in notes) as financing
- Mixing up direct and indirect method presentation formats
- Failing to show tax and dividend paid separately from operating/investing
- Forgetting to adjust for non-cash items like foreign exchange movements
Practice Tips:
- Always draw a T-account for cash to verify: Opening + Inflows − Outflows = Closing
- In consolidated cash flow questions, remember to eliminate intra-group dividends and transactions
- For not-for-profit entities, operating cash flow is computed differently — focus on receipts from and payments to members
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