Statement of cash flows
Why profit isn’t cash, and how to prepare the IAS 7 statement using the indirect method.
ACCA exams this helps with: FA Financial Accounting FR Financial Reporting See the ACCA map
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What it is: A statement that shows where cash came from and where it went during one year.
Why you need it: Profit and cash are different. A sale counts as profit when it is made, even if the customer pays later. So a business can make a profit and still run out of cash.
How it is laid out: Three sections. Operating activities is cash from day-to-day trading. Investing activities is cash spent on, or received from, long-term assets. Financing activities is cash from or to lenders and owners. The total change in cash links the opening and closing cash.
Example. A shop sells £10,000 of goods on credit in December. The £10,000 is in this year’s profit. The cash arrives in January, so it is not in this year’s cash flow.
Key words
- Operating activities
- In the statement of cash flows: cash from the business’s normal day-to-day trading, such as cash from customers and payments to staff and suppliers.Example: Cash received from customers of £400,000 is an operating cash flow.
- Investing activities
- In the statement of cash flows: cash paid for, or received from selling, long-term assets and investments.Example: Buying equipment for £30,000 and selling an old van for £5,000 are investing activities.
- Financing activities
- In the statement of cash flows: cash received from or paid to the business’s owners and lenders.Example: Issuing new shares for £10,000 and repaying £8,000 of a loan are financing activities.
- Indirect method
- A way to work out operating cash flow. Start with profit, then add back items that did not use cash (such as depreciation) and adjust for changes in stock, receivables and payables.Example: Profit £50,000 + depreciation £12,000 − increase in stock £4,000 = £58,000 so far.
- Cash equivalents
- Investments that can be turned into a known amount of cash very quickly (usually within 3 months) with very little risk. They are counted together with cash.Example: Money in a 3-month bank deposit is a cash equivalent.
Learn
The statement of cash flows (IAS 7) shows where a company’s cash came from and where it went during the year.
It is needed because profit is not the same as cash. Three examples:
- A sale on credit counts as profit now, but the cash comes later.
- Depreciation reduces profit, but no cash is paid.
- Buying a machine uses cash, but it is not an expense.
The three sections
| Section | What goes in it | Examples |
|---|---|---|
| Operating activities | Cash from day-to-day trading | Cash from customers, payments to suppliers and staff, tax paid |
| Investing activities | Cash spent on, or received from, long-term assets | Buying machinery, money received from selling a van |
| Financing activities | Cash from or to lenders and shareholders | Issuing shares, taking out or repaying loans, dividends paid |
Operating activities: the indirect method
Start with profit before tax. Then change it, step by step, into cash:
- Add back expenses that used no cash. Add depreciation and any loss on selling an asset. Take away any profit on selling an asset (the cash from the sale goes in investing).
- Add back finance costs (interest). The interest actually paid is shown on its own line further down.
- Adjust for working capital (inventory, receivables and payables), using the table below.
- The answer is cash generated from operations. Then take away interest paid and tax paid.
| Change during the year | What to do | Why |
|---|---|---|
| Inventory goes up | Take it away | Cash was spent on stock that is not sold yet |
| Trade receivables go up | Take it away | Sales were made, but customers have not paid yet |
| Trade payables go up | Add it | Costs were counted, but the cash has not been paid yet |
| Any of these goes down | Do the opposite | The effect is reversed |
Example: Profit before tax £50,000. Depreciation £8,000. Receivables went up by £3,000. Payables went up by £1,000. Cash generated from operations = £50,000 + £8,000 − £3,000 + £1,000 = £56,000.
Watch it explained
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Videos from YouTube tutors
These videos are made by independent tutors on YouTube, not by Trial Balance. Some use US terms or older exam names (for example F7 for FR), but the principles are the same.
Worked example
Profit before tax £50,000; depreciation £12,000; finance costs £3,000 (all paid); inventories rose by £4,000; receivables fell by £2,000; payables rose by £1,500; tax paid £9,000. Bought equipment for £30,000 and sold old equipment for £5,000. Issued shares for £10,000, repaid £8,000 of a loan and paid dividends of £6,000. Opening cash was £7,000.
| £ | £ | |
| Cash flows from operating activities | ||
| Profit before tax | 50,000 | |
| Add: Depreciation | 12,000 | |
| Add: Finance costs | 3,000 | |
| Increase in inventories | (4,000) | |
| Decrease in trade receivables | 2,000 | |
| Increase in trade payables | 1,500 | |
| Cash generated from operations | 64,500 | |
| Interest paid | (3,000) | |
| Tax paid | (9,000) | |
| Net cash from operating activities | 52,500 | |
| Cash flows from investing activities | ||
| Purchase of property, plant and equipment | (30,000) | |
| Proceeds from sale of equipment | 5,000 | |
| Net cash used in investing activities | (25,000) | |
| Cash flows from financing activities | ||
| Proceeds from issue of shares | 10,000 | |
| Repayment of loan | (8,000) | |
| Dividends paid | (6,000) | |
| Net cash used in financing activities | (4,000) | |
| Net increase in cash and cash equivalents | 23,500 | |
| Cash and cash equivalents at 1 January | 7,000 | |
| Cash and cash equivalents at 31 December | 30,500 | |
The company made £50,000 of profit, but its cash only rose by £23,500, mainly because it spent £30,000 on new equipment.
Practice questions
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