Last reviewed: July 2026.
The statement of cash flows explains why cash and cash equivalents changed during the reporting period. It should be read together with the statement of profit or loss and the statement of financial position because the three statements describe different aspects of the same transactions.
Profit measures performance using accrual accounting. The statement of financial position reports assets, liabilities and equity at a date. The cash-flow statement reports cash movements during the period and classifies them as operating, investing or financing activities.
The core cash reconciliation
The basic relationship is:
Opening cash and cash equivalents + net cash movement = closing cash and cash equivalents
IAS 7 requires the components of cash and cash equivalents to be disclosed and reconciled to the equivalent amounts in the statement of financial position. Non-cash investing and financing transactions are excluded from the cash-flow statement but disclosed separately.
How profit links to operating cash flow
Under the indirect method, the operating section begins with a profit subtotal and adjusts it to a cash basis. Typical adjustments include:
- adding back depreciation, amortisation and other non-cash expenses;
- removing gains or losses whose cash effects belong to investing or financing activities;
- adjusting for movements in inventory, receivables and payables;
- reflecting cash taxes, interest and other items according to the applicable classification requirements.
A profitable company can have weak operating cash flow if customers have not paid, inventory has grown rapidly or suppliers were paid sooner. A loss-making company can temporarily report positive operating cash flow if it collects old receivables or delays supplier payments. Neither result should be interpreted without context.
How the statement of financial position links to cash flow
| Change visible elsewhere | Typical cash-flow connection | Why the movement may differ |
|---|---|---|
| Profit or loss | Starting point for the indirect method. | Profit includes non-cash items and accruals. |
| Trade receivables | An increase normally reduces operating cash in the indirect reconciliation. | Revenue can be recognised before cash is collected. |
| Inventory | An increase normally uses operating cash. | Purchases or production can occur before the related sale. |
| Trade payables | An increase normally supports operating cash. | Expenses or inventory can be recognised before suppliers are paid. |
| Property, plant and equipment | Cash purchases and disposal proceeds are generally investing cash flows. | Depreciation is non-cash; disposals may include a gain or loss in profit. |
| Borrowings | Loan proceeds and repayments are generally financing cash flows. | Interest classification follows the applicable requirements and policy context. |
| Share capital and dividends | Share issues and distributions affect financing cash flows. | Equity movements may include non-cash or reclassification items. |
Balance-sheet movements are a starting point, not a complete cash-flow answer. The movement in property, plant and equipment may combine cash purchases, depreciation, disposals, revaluations, acquisitions and foreign-exchange effects. Additional information is needed to isolate the cash transactions.
Operating, investing and financing activities
- Operating activities are the entity’s principal revenue-producing activities and other activities not classified as investing or financing.
- Investing activities include acquiring and disposing of long-term assets and investments that are not cash equivalents.
- Financing activities change the size or composition of contributed equity and borrowings.
See the detailed guide to classifying cash flows under IAS 7 and the lesson on preparing a cash-flow statement.
Worked connection example
Assume a business reports profit of 100 CU. Depreciation is 30 CU, trade receivables increase by 25 CU, inventory decreases by 10 CU and trade payables increase by 15 CU. Ignoring tax and other items, the indirect operating cash calculation is:
- Profit: 100 CU
- Add depreciation: 30 CU
- Subtract increase in receivables: 25 CU
- Add decrease in inventory: 10 CU
- Add increase in payables: 15 CU
- Indicative operating cash flow: 130 CU
The 30 CU depreciation reduced profit but did not use cash. The receivables increase means some recognised revenue has not yet been collected. The inventory decrease releases cash tied up in stock, while the payables increase means some recognised costs have not yet been paid.
Linking investing and financing movements
If equipment increases by 500 CU, it does not automatically mean cash purchases were 500 CU. The business may have purchased assets for cash, obtained them through a lease, disposed of old assets, recorded depreciation or acquired a subsidiary. A reconciliation of the asset account helps identify cash additions and disposal proceeds.
Borrowing movements also need analysis. Opening debt plus cash proceeds, non-cash additions, foreign-exchange changes and other movements less cash repayments should reconcile to closing debt. IAS 7 requires disclosures that enable users to evaluate changes in liabilities arising from financing activities.
Current IFRS presentation context
The IFRS Foundation’s IAS 7 overview explains the operating, investing and financing categories and the direct and indirect methods. IFRS 18, effective for annual periods beginning on or after 1 January 2027 unless applied earlier, amended IAS 7. Among the changes, entities applying IFRS 18 use the required operating-profit subtotal as the starting point for the indirect method and apply updated requirements for classifying interest and dividend cash flows.
The IFRS 18 overview should therefore be considered when preparing transition plans and future-period statements.
Analytical questions to ask
- Does operating cash flow support the reported profit over time?
- Are receivables or inventory growing faster than revenue?
- Is the business funding asset purchases from operations, new debt or equity?
- Are financing cash inflows masking weak operating performance?
- Do major balance-sheet movements reconcile to cash and non-cash explanations?
- Are cash equivalents and restricted balances clearly understood?
For liquidity analysis, compare the cash-flow information with the current ratio and the broader guide to accounting ratio analysis. A strong current ratio does not necessarily mean that operating cash generation is strong.
Key takeaway
The cash-flow statement is a bridge between accrual performance and changes in financial position. Profit explains economic performance, the statement of financial position shows accumulated balances, and the cash-flow statement explains cash movement. Reliable analysis reconciles all three instead of reading any one statement in isolation.