Last reviewed: July 2026.
The statement of cash flows explains how cash and cash equivalents changed during a reporting period. It connects profit, working capital, investment and financing decisions, helping users assess liquidity, cash generation and the entity’s ability to meet obligations.
Purpose of the statement
Profit is based on accrual accounting and includes non-cash items, timing differences and estimates. The statement of cash flows focuses on actual cash movements. It helps users understand why a profitable entity may have weak cash flow, or why a loss-making entity may temporarily report a cash increase.
IAS 7 classifies cash flows as operating, investing or financing. The three sections reconcile opening cash and cash equivalents to the closing balance.
Cash and cash equivalents
Cash includes cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments readily convertible to known amounts of cash and subject to insignificant value-change risk. They are held to meet short-term cash commitments rather than for investment return.
Some bank overdrafts repayable on demand may form part of cash management when they fluctuate from positive to overdrawn. Restricted deposits and investments that do not meet the definition are not automatically cash equivalents.
Operating activities
Operating activities are the principal revenue-producing activities and other activities that are not investing or financing. Typical examples include receipts from customers, payments to suppliers and employees, and many tax and interest cash flows depending on the entity’s consistent classification policy and applicable requirements.
Operating cash flow indicates how far normal operations generate the cash needed to maintain capacity, service debt, pay distributions and invest without relying on external finance.
Direct and indirect methods
Under the direct method, major classes of gross operating receipts and payments are shown. Under the indirect method, profit or loss is adjusted for non-cash items, working-capital changes and items whose cash effects belong in investing or financing activities.
| Indirect adjustment | Typical effect |
|---|---|
| Depreciation expense | Add back because it is non-cash |
| Gain on asset disposal | Deduct from operating profit; proceeds are investing |
| Increase in inventory | Deduct as cash is tied up |
| Increase in trade payables | Add because payment is deferred |
Both methods should arrive at the same net operating cash flow when prepared correctly.
Investing activities
Investing cash flows relate to acquiring and disposing of long-term assets and investments not treated as cash equivalents. Purchases of property, plant and equipment are usually outflows; sale proceeds are inflows. Loans made to other parties and collections may also be investing activities depending on the entity and the applicable classification rules.
Only cash actually paid or received belongs in the statement. An asset acquired through a lease or share issue is a non-cash transaction and is disclosed separately rather than presented as a cash flow.
Financing activities
Financing activities change the size or composition of equity and borrowings. Examples include proceeds from issuing shares or debt, repayments of borrowings, and certain lease payments. Clear financing classification helps users predict claims on future cash flows.
Gross presentation is normally important. Netting receipts and payments can hide the scale of refinancing unless a specific net-presentation condition is met.
Worked indirect-method example
| Operating reconciliation | Amount |
|---|---|
| Profit before tax | $80,000 |
| Add depreciation | $20,000 |
| Deduct gain on disposal | ($5,000) |
| Increase in inventory | ($12,000) |
| Decrease in receivables | $8,000 |
| Increase in payables | $6,000 |
| Cash generated from operations | $97,000 |
Cash interest and tax payments are then included according to the entity’s classification and the applicable requirements. Investing and financing sections are prepared from asset schedules, loan records, equity records and bank evidence.
Preparing the statement reliably
- Reconcile opening and closing cash to the general ledger and bank reconciliations.
- Use fixed-asset movements to derive cash purchases and disposal proceeds.
- Use debt and equity roll-forwards to identify financing flows.
- Separate cash and non-cash transactions.
- Check foreign-exchange effects and acquisitions or disposals of businesses.
- Tie every line to a supporting schedule.
A common error is using balance-sheet movements without adjusting for non-cash changes. For example, PPE movement may include depreciation, revaluation, impairment, acquisitions and disposals.
Analysis and warning signs
Strong operating cash flow relative to profit can indicate good cash conversion, while repeated operating deficits may signal working-capital pressure or weak profitability. Large investing outflows may reflect growth rather than distress, and financing inflows may temporarily support cash while increasing future obligations.
Users should analyse several periods and read the notes. Classification choices, supplier-finance arrangements, restricted cash and non-cash financing can materially affect interpretation.
Related accounting guides
- Preparing a cash flow statement
- Cash flow statements—indirect method
- Format of the cash flow statement
Authoritative references
Practical takeaway
Build the statement from reconciled ledgers and movement schedules, not from unsupported plug figures. Classify each cash movement by its economic nature, disclose material non-cash transactions separately and reconcile the final cash balance to bank and ledger evidence.
Implementation note
A strong cash-flow preparation file links every material line to the statement of financial position, profit or loss, notes and supporting schedules. Use a movement analysis for debt, leases, property, provisions and working capital, then identify which movements are cash and which are non-cash. Reconcile the final net movement to opening and closing cash and cash equivalents. Review unusual classifications consistently with the entity’s policy and keep evidence for restricted cash, bank overdrafts and significant financing transactions.
Free practical resource: Use our 13-week cash flow, bank reconciliation and accounting controls templates to turn these concepts into a repeatable working process.