Statement of Cash Flows

What is Statement of Cash Flows?

IAS 7.10 requires the entity to present cash flows classified by activity type. Operating activities cover cash from the entity's principal revenue-producing activities (IAS 7.14). Investing activities capture cash spent on or received from long-term assets, including property, plant and equipment, intangible assets, equity investments, and debt instruments in other entities (IAS 7.16). Financing activities reflect cash movements that change the size and composition of equity and borrowings (IAS 7.17).

For operating activities, the entity chooses between two presentation methods. The direct method (IAS 7.18(a)) lists major classes of gross cash receipts and payments. The indirect method (IAS 7.18(b)) starts with profit or loss and adjusts for non-cash items and working capital changes, then removes items that belong to investing or financing activities. IAS 7.19 encourages the direct method, but the indirect method dominates European practice because it reconciles easily to the statement of profit or loss.

Interest paid may be classified as operating or financing; dividends paid may be classified as operating or financing (IAS 7.33). The entity must apply its chosen classification consistently. ISA 520.5 expects the auditor to build an expectation for each major cash flow line item during analytical procedures. That makes the classification choice audit-relevant: shifting interest paid between categories changes the operating cash flow figure that analysts and covenant calculations depend on.

Worked example: Rossi Alimentari S.p.A.

Client: Italian food production company, FY2025, revenue €67M, IFRS reporter. The engagement team prepares the indirect-method cash flow reconciliation and verifies classification of material items.

Step 1 — Start with profit before tax

Rossi reports profit before tax of €5.8M. The team adds back non-cash charges: depreciation of €3.2M, amortisation of €0.4M, a €0.6M increase in the provision for product warranty claims, and a €0.2M unrealised foreign exchange loss. Interest expense of €1.1M is reclassified out of operating activities because Rossi classifies interest paid as a financing activity.

Documentation note: record each adjustment from profit before tax, cross-referencing to the trial balance and the relevant working papers for depreciation, amortisation, provisions, and finance costs. Confirm the classification policy for interest paid is consistent with FY2024 under IAS 7.33.

Step 2 — Adjust for working capital movements

Trade receivables increased by €1.4M (cash outflow), inventories decreased by €0.9M (cash inflow), prepaid expenses increased by €0.2M (cash outflow), and trade payables increased by €2.3M (cash inflow). Net working capital change is a positive €1.6M.

Documentation note: reconcile each working capital movement to the opening and closing statement of financial position. Confirm no non-cash items are embedded in the movement (for example, a receivable written off should appear as a non-cash adjustment, not as a working capital change).

Step 3 — Calculate operating cash flow

Profit before tax (€5.8M) plus non-cash adjustments (€4.4M) less interest reclassified (€1.1M) plus working capital movement (€1.6M) less tax paid (€1.5M) gives operating cash flow of €9.2M.

Documentation note: record the tax paid figure by reconciling the opening and closing tax payable balances against the tax expense. Cross-reference to the current tax working paper.

Step 4 — Classify investing and financing activities

Rossi spent €4.7M on a new packaging line (investing outflow) and received €0.3M from selling old equipment (investing inflow). It drew €3.0M on a revolving credit facility (financing inflow), repaid €2.2M of term debt (financing outflow), paid €1.1M of interest (financing outflow under Rossi's policy), and paid dividends of €1.8M (also financing).

Documentation note: agree the capital expenditure to the fixed asset register additions. Confirm the equipment disposal proceeds match the carrying amount calculation in the impairment working paper. Reconcile all borrowing movements to the bank confirmation and loan agreements. Verify that the net change in cash (€9.2M minus €4.4M minus €2.1M = €2.7M) agrees to the movement in the cash line on the balance sheet.

Conclusion: Rossi's statement of cash flows is internally consistent, the €2.7M net increase in cash agrees to the balance sheet, and the interest-paid classification as financing is defensible because the entity applied it consistently with prior year.

Why it matters in practice

The FRC's 2022/23 Annual Review of Corporate Reporting found that entities frequently misclassified cash flows between operating and investing categories, particularly when proceeds from disposal of non-current assets were netted against capital expenditure instead of presented separately. IAS 7.21 requires gross presentation of investing inflows and outflows, with limited netting exceptions under IAS 7.22–24.

Teams often prepare the cash flow statement mechanically from balance sheet movements without checking whether non-cash transactions have been excluded. Acquiring equipment through a finance lease or settling a liability by issuing shares are non-cash items that IAS 7.43 requires the entity to disclose outside the statement itself. Failing to strip these out overstates both investing outflows and financing inflows.

Statement of cash flows vs. statement of profit or loss

The distinction matters because a profitable entity can still run out of cash. Revenue recognised on an accrual basis does not guarantee collection, and expenses recognised may not yet require payment. The cash flow statement strips away accrual-basis timing differences and shows what actually moved through the bank account.

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