IAS 7 Statement of Cash Flows: Summary, Practice Questions & Decision Tree

Every cash flow lands in one of three buckets (IAS 7.10). Operating activities are the principal revenue-producing activities and everything that isn't investing or financing — cash from customers, payments to suppliers and employees, and (for most entities) income taxes paid (IAS 7.13–14). Investing activities are acquisitions and disposals of long-term assets and investments — buying PPE, selling a machine, acquiring a subsidiary net of cash acquired, making loans to others (IAS 7.16). Financing activities change the size and composition of equity and borrowings — share issues, buy-backs, drawing and repaying loans, dividends paid to owners, and the capital portion of lease payments under IFRS 16 (IAS 7.17).

Interest and dividends get a choice, applied consistently (IAS 7.31–34): interest paid may be shown as operating or financing; interest and dividends received as operating or investing; dividends paid as financing or operating. Taxes on income are operating unless they can be specifically identified with an investing or financing transaction (IAS 7.35). Examiners love the classification edge cases: a machine bought on deferred credit produces a financing-style outflow only when the payments are made, and the interest element of a lease payment follows the entity's interest-paid policy while the principal is always financing.

The statement reconciles the movement in cash and cash equivalents, so the definition is load-bearing. Cash equivalents are short-term, highly liquid investments readily convertible to known amounts of cash and subject to insignificant risk of changes in value — held to meet short-term cash commitments, not for investment (IAS 7.6–7). The practical benchmark is a maturity of three months or less from acquisition. Equity investments are essentially never cash equivalents (no known cash amount); a 12-month term deposit fails on maturity; a money-market fund redeemable at a known amount qualifies. Bank overdrafts repayable on demand form a component of cash and cash equivalents — negative cash — where they are integral to the entity's cash management, with the balance swinging between positive and overdrawn (IAS 7.8).

The choice only affects the operating section — investing and financing are always presented gross. The direct method shows major classes of gross cash receipts and payments: cash collected from customers, cash paid to suppliers and employees (IAS 7.18(a), 19). IAS 7 encourages it, because it shows information the indirect method hides. The indirect method — used by nearly every listed company — starts from profit or loss and works backwards: strip out non-cash items (depreciation, amortisation, impairments, provisions), remove items belonging to other activities (disposal gains and losses, investment income), and adjust for movements in working capital (IAS 7.18(b), 20).

The indirect logic in one line: profit before tax + non-cash charges − non-cash credits − increases in inventory and receivables + increases in payables = cash generated from operations; then deduct interest paid and tax paid to reach net cash from operating activities. The signs are where marks are lost: an INCREASE in receivables means customers owe more — cash not yet collected — so it is SUBTRACTED; an increase in payables means suppliers financed the entity, so it is ADDED.

Transactions with no cash movement never enter the statement — however large. Acquiring an asset under a lease, converting debt to equity, buying a business by issuing shares: all excluded from the statement of cash flows and disclosed elsewhere in the financial statements instead (IAS 7.43–44). This is a favourite trick in exam questions: a CU 900,000 building acquired entirely under a lease produces no investing outflow at all — only the subsequent lease payments appear, split between financing (principal) and the interest line.