Financial Accounting · Statement of cash flows (excluding partnerships)

IAS 7 Statement of Cash Flows: Purpose and Format

Updated 11 October 2026 · Fact-checked

The statement of cash flows (IAS 7) shows how a business generated and used cash during a period. It groups cash movements into operating, investing and financing activities. The total equals the change in cash and cash equivalents. To answer questions, classify each item by its nature and check the totals reconcile.

Understand Purpose and Format of the Statement of Cash Flows

Profit is not cash. Profit follows the accrual concept: you record sales when earned, not when paid. Depreciation reduces profit but no cash leaves. Buying a machine uses cash but is not an expense in full. So a business can be profitable and still run out of cash. This is why users want a statement of cash flows.

The statement of cash flows shows where cash came from and where it went. Lenders, suppliers and investors use it to judge whether the business can pay debts, fund growth and pay dividends. Cash flow is also less affected by accounting policies and estimates, such as depreciation, than profit is, so it helps with comparison. It can still be affected by the timing of payments and by classification choices.

IAS 7 defines cash as cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and subject to an insignificant risk of changes in value. An investment normally qualifies only if it has a short maturity, usually three months or less from the date of acquisition. Bank overdrafts repayable on demand that form an integral part of cash management are included as a negative part of cash and cash equivalents.

IAS 7 requires cash flows to be split into three headings. Operating activities are the main revenue-producing activities and anything not investing or financing. Investing activities are buying and selling non-current assets and other investments not in cash equivalents. Financing activities change the size and make-up of equity and borrowings, such as issuing shares, raising or repaying loans, and paying dividends.

The statement ends with the net increase or decrease in cash and cash equivalents, added to the opening balance to give the closing balance. That closing figure must agree to the statement of financial position (cash plus equivalents, less overdrafts where included).

Key formulas to remember

Cash and cash equivalents: Cash and cash equivalents = cash + demand deposits + short-term highly liquid investments (insignificant risk of value change) − repayable-on-demand overdrafts; Investments usually qualify only if maturity is three months or less from acquisition.
Three headings: Net change in cash = operating cash flow + investing cash flow + financing cash flow; Each item belongs under one heading according to its nature.
Closing cash proof: Opening cash and equivalents + net increase (or − net decrease) = closing cash and equivalents; Closing figure must agree to the statement of financial position.
Typical classification: Operating: receipts from customers, payments to suppliers and employees. Investing: purchase/sale of non-current assets. Financing: share issues, loan receipts and repayments, dividends paid; IAS 7 allows interest and dividends paid to be shown as operating or financing, and interest and dividends received as operating or investing, applied consistently. ACCA questions normally show interest paid and dividends paid under the standard layout the question specifies.

How to solve Purpose and Format of the Statement of Cash Flows questions

Use this method for any question on the purpose or format of the statement of cash flows.

1Read the question and decide what is asked: a definition, a classification, or a calculation of cash and cash equivalents.
2For cash and equivalents, include cash on hand, demand deposits, and investments with a maturity of three months or less from acquisition.
3Deduct overdrafts that are repayable on demand and used in cash management.
4For each cash flow, ask what it is: day-to-day trading (operating), buying or selling long-term assets (investing), or raising or repaying finance (financing).
5Check the direction: inflow adds, outflow deducts.
6Ignore non-cash items such as depreciation, accruals and share issues by bonus; they are not cash flows.
7Total each heading, then reconcile opening cash plus net change to closing cash.

Quickest way: Three-bucket sort

When to use it: Use for multiple choice and multiple response questions asking which heading an item falls under or what counts as cash equivalents.

Ask: does it relate to long-term assets? Then investing.
Ask: does it relate to owners' money or loans? Then financing.
Everything else about trading is operating.
For equivalents, test two things: short maturity from acquisition (three months or less) and little risk of value change.
Reject any option that is a non-cash item.

Common mistakes in Purpose and Format of the Statement of Cash Flows

Treating profit as the cash generated by the business.
Students forget accruals, depreciation and credit sales create gaps between profit and cash.
Fix: Remember that profit is an accruals measure. Only cash receipts and payments appear in the statement.
Counting any investment as a cash equivalent.
The word liquid is read loosely.
Fix: Check the maturity from the date of acquisition (three months or less) and that the value risk is insignificant.
Putting dividends paid or loan repayments under operating activities.
They feel like everyday payments.
Fix: They change equity and borrowings, so under the standard layout they are financing.
Ignoring the overdraft when finding closing cash.
Overdrafts look like loans, so they are treated as financing.
Fix: Repayable-on-demand overdrafts that are part of cash management reduce cash and cash equivalents.
Including depreciation as a cash outflow.
It is a large expense in the statement of profit or loss.
Fix: Depreciation is non-cash. Buying the asset is the investing cash outflow.

Worked examples

Example 1

At the year end a company has: cash in hand $12,000; bank current account $48,000; a deposit account repayable on demand $30,000; a government bill with an original maturity of 3 months, acquired 2 months before the year end, $20,000; a 2-year bond $50,000; and a bank overdraft repayable on demand $15,000 used in cash management. Calculate cash and cash equivalents.

Show the solution

Include cash in hand: $12,000.
Include bank current account: $48,000.
Include demand deposit: $30,000.
Include the government bill: original maturity of three months from acquisition, so a cash equivalent: $20,000.
Exclude the 2-year bond: long maturity.
Deduct the overdraft: $15,000.
Total = 12,000 + 48,000 + 30,000 + 20,000 − 15,000 = 95,000.

Answer: $95,000

Example 2

Classify each cash flow under IAS 7 headings: (1) cash received from customers; (2) purchase of a delivery van for cash; (3) repayment of a bank loan; (4) proceeds from issuing new shares; (5) proceeds from selling old machinery.

Show the solution

Customer receipts come from trading, so operating.
The van is a non-current asset purchase, so investing (outflow).
Loan repayment reduces borrowings, so financing (outflow).
Share issue proceeds raise equity, so financing (inflow).
Machinery sale proceeds come from disposing of a non-current asset, so investing (inflow).

Answer: (1) Operating; (2) Investing; (3) Financing; (4) Financing; (5) Investing.

Exam tips

In objective tests, scan the options for non-cash items such as depreciation or bonus issues; they are never cash flows.
For cash equivalents, check the maturity date from when the investment was bought, not the time left at the year end.
Know the headings well enough to classify in seconds, so you save time for the longer multi-task questions later.
Write the direction of each flow (inflow or outflow) next to it before adding up in number entry questions.
Always reconcile to opening and closing cash if figures are given; it catches sign errors.

Practice questions from Statement of cash flows (excluding partnerships)

Purpose and Format of the Statement of Cash Flows in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Purpose and Format of the Statement of Cash Flows: frequently asked questions

What is the difference between profit and cash flow?

Profit is income less expenses on an accruals basis, including non-cash items like depreciation and credit sales not yet paid. Cash flow is the actual money received and paid. A business can be profitable but short of cash.

What are cash and cash equivalents in IAS 7?

Cash is cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments convertible to known amounts of cash with an insignificant risk of value change, usually with a maturity of three months or less from acquisition. Some overdrafts are deducted.

Which activities appear in the statement of cash flows?

There are three: operating, investing and financing. Operating covers trading, investing covers long-term assets and investments, and financing covers equity and borrowings.

Why does IAS 7 matter if we already have a statement of profit or loss?

It shows liquidity and the ability to pay debts and dividends, which profit does not show. Cash flow is also less affected by accounting policies and estimates such as depreciation, so it helps users compare businesses. It can still be affected by timing and classification choices.