A statement of cash flows explains how cash and cash equivalents changed during a period. IAS 7 classifies cash flows into operating, investing and financing activities.
Classification matters because identical total cash movements can tell very different stories. Users need to separate cash generated by normal operations from long-term investment and financing.
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 with insignificant value risk. They are held to meet short-term cash commitments, not primarily for investment return.
The Three Categories
| Category | Meaning | Question answered |
|---|---|---|
| Operating | Principal revenue-producing activities and other activities not investing or financing. | Did ordinary operations generate cash? |
| Investing | Acquisition and disposal of long-term assets and non-cash-equivalent investments. | How much was invested in long-term resources? |
| Financing | Changes in contributed equity and borrowings. | How was capital raised or repaid? |
Operating Activities
Common inflows include receipts from customers, fees and commissions. Common outflows include payments to suppliers, employees, landlords and governments. Inventory purchases are normally operating, not investing.
Direct and Indirect Methods
Direct method
Reports major classes of gross cash receipts and payments.
Indirect method
Reconciles a profit subtotal to operating cash flow by adjusting for noncash items, working-capital changes, accruals and items linked to investing or financing.
IFRS 18, effective from 1 January 2027, requires entities using the indirect method to begin with the operating profit or loss subtotal required by IFRS 18.
Investing Activities
Typical investing outflows include purchases of equipment, intangible assets, investments and businesses. Typical inflows include asset-sale proceeds, loan repayments received and cash from disposing of a subsidiary.
Financing Activities
Typical financing inflows include share issues and borrowings. Outflows include loan principal repayments, share repurchases, lease-liability principal and distributions to owners when classified as financing.
Classification Examples
| Cash flow | Likely category | Reason |
|---|---|---|
| Cash received from customers | Operating | Principal revenue activity. |
| Purchase of machinery | Investing | Long-term productive asset. |
| Bank-loan proceeds | Financing | Increases borrowings. |
| Repayment of loan principal | Financing | Reduces borrowings. |
| Sale of equipment | Investing | Disposal of a long-term asset. |
| Purchase of inventory | Operating | Normal trading activity. |
| Cash paid to acquire a subsidiary | Investing | Obtaining control of a business. |
| Cash share issue | Financing | Increases contributed equity. |
Interest, Dividends and Tax
Interest and dividend classification depends on the reporting requirements and the entity’s main business activities. IAS 7 historically permitted some choices when applied consistently. IFRS 18 introduces new requirements from 2027. Income-tax cash flows are normally operating unless specifically identifiable with an investing or financing transaction.
Subsidiary Acquisitions and Disposals
Cash flows from obtaining or losing control of a business are shown separately as investing activities. Cash consideration is adjusted for cash and cash equivalents acquired or disposed of with the business.
Noncash Transactions
Noncash investing and financing transactions are excluded from the statement but disclosed when material. Examples include equipment acquired by lease, shares issued to acquire a business and debt converted to equity.
Worked Example
| Transaction | Amount | Classification |
|---|---|---|
| Cash collected from customers | $500,000 | Operating inflow |
| Suppliers and employees | ($390,000) | Operating outflow |
| Tax paid | ($20,000) | Operating outflow |
| Equipment purchased | ($80,000) | Investing outflow |
| Old equipment sold | $10,000 | Investing inflow |
| Loan proceeds | $100,000 | Financing inflow |
| Loan principal repaid | ($40,000) | Financing outflow |
Net operating cash flow is $90,000, net investing cash flow is −$70,000 and net financing cash flow is $60,000. The net increase in cash is $80,000.
Common Errors
- Classifying every profit-or-loss item as operating.
- Including noncash transactions.
- Treating inventory purchases as investing.
- Classifying loan principal as an expense.
- Using an obsolete fragmented heading structure.
- Netting amounts that should be presented gross.
Judgement and Current Developments
Complex items may contain operating, investing and financing components. Classification follows the nature of the activity and applicable standards. The IASB is researching wider IAS 7 improvements in 2026, but tentative decisions are not current requirements until final amendments are issued and effective.
Gross and Net Presentation
Major classes of investing and financing cash receipts and payments are normally presented gross. Net presentation can hide the scale of activity and is permitted only in specified circumstances, such as certain cash flows collected and paid on behalf of customers or items with quick turnover, large amounts and short maturities.
Foreign Currency Cash Flows
Foreign-currency cash flows are translated using the exchange rate at the date of the cash flow, although an appropriate average rate may be used when it approximates actual rates. Exchange differences on cash and cash equivalents are presented separately so the opening and closing balances reconcile.
Bank Overdrafts and Restricted Cash
Bank overdrafts are usually financing liabilities. In limited circumstances, an overdraft repayable on demand that forms an integral part of day-to-day cash management can be included in cash and cash equivalents. Restricted cash remains an asset, but the nature and restrictions may require separate presentation or disclosure.
Interest and Dividends around IFRS 18
Before an entity applies IFRS 18, IAS 7 allows certain interest and dividend cash flows to be classified consistently within permitted categories. IFRS 18 narrows and restructures these requirements, especially for entities without specified main business activities. Preparers should document which requirements are effective for the reporting period and avoid mixing pre-2027 and post-2027 teaching rules.
Gross and Net Presentation
Major classes of investing and financing cash receipts and payments are normally presented gross. Net presentation can hide the scale of activity and is permitted only in specified circumstances, such as certain cash flows collected and paid on behalf of customers or items with quick turnover, large amounts and short maturities.
Foreign Currency Cash Flows
Foreign-currency cash flows are translated using the exchange rate at the date of the cash flow, although an appropriate average rate may be used when it approximates actual rates. Exchange differences on cash and cash equivalents are presented separately so the opening and closing balances reconcile.
Bank Overdrafts and Restricted Cash
Bank overdrafts are usually financing liabilities. In limited circumstances, an overdraft repayable on demand that forms an integral part of day-to-day cash management can be included in cash and cash equivalents. Restricted cash remains an asset, but the nature and restrictions may require separate presentation or disclosure.
Interest and Dividends around IFRS 18
Before an entity applies IFRS 18, IAS 7 allows certain interest and dividend cash flows to be classified consistently within permitted categories. IFRS 18 narrows and restructures these requirements, especially for entities without specified main business activities. Preparers should document which requirements are effective for the reporting period and avoid mixing pre-2027 and post-2027 teaching rules.
Frequently Asked Questions
What are the three types of cash flow?
Operating, investing and financing.
Is inventory an investing cash flow?
No. Inventory purchases are normally operating cash flows.
Is depreciation a cash outflow?
No. It is a noncash expense and is adjusted under the indirect method.
Where is equipment purchase shown?
Normally as an investing cash outflow.
Does IFRS 18 change IAS 7?
Yes. It changes the indirect-method starting point and introduces new interest and dividend classification requirements from 2027.
Related Guides
- Benefits and Limitations of Cash Flow Statements
- Balance Sheet Explained
- Trading and Profit and Loss Account
- Capital Gearing Ratio
Conclusion
Strong accounting information comes from accurate records, appropriate judgement, consistent policies and clear disclosures. The topic should be applied in the context of the entity’s facts, reporting framework and materiality.
Authoritative references: IAS 7, IFRS 18, ACCA Cash Flow Statements.