Financial Reporting · Preparation of single entity financial statements

Statement of Cash Flows under IAS 7 for ACCA Financial Reporting

Updated 11 October 2026 · Fact-checked

A statement of cash flows under IAS 7 shows how cash and cash equivalents changed during the year, split into operating, investing and financing activities. With the indirect method, you start from profit before tax, adjust for non-cash items and working capital changes, then add the other cash flows.

Understand Statement of Cash Flows under IAS 7

Profit is not cash. A company can report a profit and still run out of money, because profit includes accruals, depreciation and credit sales. The statement of cash flows answers a different question: where did cash come from, and where did it go?

IAS 7 requires cash flows to be grouped into three activities. Operating activities are the main revenue-producing activities, such as receipts from customers and payments to suppliers and employees. Investing activities are buying and selling non-current assets and other long-term investments. Financing activities change the size or make-up of equity and borrowings, such as issuing shares, raising or repaying loans, and (usually) paying lease principal.

The standard allows two ways to show operating cash flow. The direct method lists actual cash receipts and payments. The indirect method starts with profit before tax and reconciles it to cash generated from operations. ACCA FR questions almost always use the indirect method, because the data comes from the statement of financial position and profit or loss.

The reconciliation works in three moves. Add back non-cash expenses such as depreciation. Remove items that belong in another section, such as profit on disposal (investing) and finance costs (shown separately as interest paid). Then adjust for working capital: an increase in inventory or receivables uses cash, and an increase in payables saves cash.

The statement ends by agreeing to the movement in cash and cash equivalents. These are short-term, highly liquid investments that are readily convertible to known amounts of cash and carry an insignificant risk of change in value. Bank overdrafts repayable on demand that form part of cash management are included as negative cash.

Key rules to remember

Cash generated from operations: Profit before tax + depreciation and amortisation + finance costs − investment income + loss on disposal (or − profit on disposal) ± changes in working capital; Increase in inventory or receivables is deducted. Increase in payables is added. Decreases do the opposite.
Net cash from operating activities: Cash generated from operations − interest paid − income tax paid; Interest paid can alternatively go in financing, if you apply the policy consistently.
Tax paid: Opening tax liability + tax charge for the year − closing tax liability; Include deferred tax movements in the charge and the liability if the question includes deferred tax. Use a T-account.
Purchase of property, plant and equipment: Closing carrying amount − opening carrying amount + depreciation + carrying amount of disposals − revaluation surplus; Subtract revaluation surplus because it is not a cash flow. Add acquisitions made through leases only as non-cash.
Proceeds of disposal: Carrying amount of asset sold + profit on disposal (or − loss); Shown in investing activities.
Dividends paid: Opening retained earnings + profit for the year − closing retained earnings; Use this when dividends paid are not given. Dividends paid can be operating or financing.
Interest paid: Finance cost in profit or loss + opening interest accrual − closing interest accrual; Where interest is paid in full, interest paid equals the finance cost.
Proceeds from share issue: Increase in share capital + increase in share premium; Exclude bonus issues, which are non-cash.
Net change in cash: Net cash from operating + investing + financing activities = closing cash and cash equivalents − opening cash and cash equivalents; Your final check. If it does not agree, find the error.

How to solve Statement of Cash Flows under IAS 7 questions

Use the same layout every time. Work out each figure on the side first, then complete the statement.

1Read the requirement. Note whether you need the full statement, only the operating reconciliation, or a single figure such as tax paid.
2Set up the pro forma: operating reconciliation, then interest and tax paid, then investing, then financing, then net change in cash and the opening and closing balances.
3Start the reconciliation with profit before tax. Add depreciation and finance costs, and adjust for disposal profit or loss and any investment income.
4Calculate the changes in inventory, receivables and payables from the opening and closing statements of financial position, and adjust each in the correct direction.
5Use T-accounts or formulas for tax paid, non-current asset purchases, interest paid and dividends paid. Do not guess these.
6Work out the financing flows: share issues, loans raised or repaid, lease principal paid and dividends if you classify them as financing.
7Add the three sections to get the net change in cash and agree it to the movement in cash and cash equivalents. Include any overdraft as negative cash.
8Label each line clearly and show brackets for outflows. Keep your workings, because method marks are available in the constructed response section.

Quickest way: Movement-first approach

When to use it: Use this when time is short, for example in a 20-mark constructed response question or a Section A or B question asking for one figure.

Write the headings and the pro forma in two minutes. This protects your layout marks.
For each statement of financial position line, write the movement (closing minus opening). Every movement must end up in the statement or in a non-cash item.
Decide the section for each movement: working capital goes to operating, non-current assets to investing, loans and share capital to financing.
Use the three T-accounts that matter most: tax, property, plant and equipment, and retained earnings.
Add up the sections and check against the change in cash. If the check fails, recheck the signs on working capital first.

Common mistakes in Statement of Cash Flows under IAS 7

Adjusting working capital in the wrong direction
Students memorise the rule for the asset but apply it to a liability without thinking about the cash effect.
Fix: Ask: did this item use cash or save cash? A higher receivable means customers have not paid yet, so cash is lower. A higher payable means you have not paid suppliers yet, so cash is higher.
Forgetting to add back finance costs, then also deducting interest paid
Students start from profit before tax, which is after interest, and do not see the interest in the reconciliation.
Fix: Add back the finance cost in the reconciliation. Deduct interest actually paid after cash generated from operations. This keeps interest in only one place.
Using the tax charge instead of tax paid
The tax figure in profit or loss is easy to find, so students use it directly.
Fix: Build the tax account: opening liability plus charge minus closing liability gives the cash paid. Include deferred tax in the same working if it is given.
Showing the profit on disposal in operating activities and the proceeds in investing without removing the profit
Students include the proceeds correctly but forget the profit is already inside profit before tax.
Fix: Deduct the profit (or add the loss) in the reconciliation. Show the full proceeds in investing activities.
Treating non-cash items as cash flows
Revaluation surpluses, bonus issues, and assets acquired by leases move the statement of financial position but not cash.
Fix: Before using a movement, ask whether cash actually moved. Remove revaluations from the property, plant and equipment working and exclude bonus issues from share proceeds.
Ignoring an overdraft in cash and cash equivalents
Students take only the cash and bank asset and leave the overdraft in current liabilities.
Fix: If the overdraft is repayable on demand and used in cash management, net it against cash. Opening and closing balances must both be treated the same way.

Worked examples

Example 1

Reconcile profit before tax to net cash from operating activities. Profit before tax is $480,000 after charging finance costs of $40,000, depreciation of $120,000 and after crediting a profit on disposal of property, plant and equipment of $15,000. Inventory increased by $60,000, receivables increased by $45,000 and payables increased by $30,000. Interest paid was $40,000 and tax paid was $90,000.

Show the solution

Start with profit before tax: $480,000.
Add back finance costs: 480,000 + 40,000 = 520,000.
Add back depreciation: 520,000 + 120,000 = 640,000.
Deduct the profit on disposal, because it belongs in investing: 640,000 − 15,000 = 625,000.
Increase in inventory uses cash: 625,000 − 60,000 = 565,000.
Increase in receivables uses cash: 565,000 − 45,000 = 520,000.
Increase in payables saves cash: 520,000 + 30,000 = 550,000. This is cash generated from operations.
Deduct interest paid of 40,000 and tax paid of 90,000: 550,000 − 40,000 − 90,000 = 420,000.

Answer: Cash generated from operations is $550,000. Net cash from operating activities is $420,000.

Example 2

Prepare the statement of cash flows (in $000) for the year. Opening and closing statements of financial position: property, plant and equipment 500 and 640; inventory 100 and 130; receivables 80 and 95; cash and bank 20 and (40) overdraft; payables 70 and 85; tax payable 30 and 35; loan 150 and 100; share capital and premium 300 and 380; retained earnings 150 and 225. Profit before tax was 160 after finance costs of 12 (paid in full), depreciation of 70 and a profit on disposal of 10. The tax charge was 45. Equipment with a carrying amount of 40 was sold. Dividends paid were 40. Treat dividends paid as financing and the overdraft as part of cash.

Show the solution

Reconcile: 160 + finance costs 12 + depreciation 70 − profit on disposal 10 = 232.
Working capital: inventory increase (30) gives 202; receivables increase (15) gives 187; payables increase 15 gives 202. Cash generated from operations is 202.
Interest paid is 12, because the finance cost was paid in full.
Tax paid: opening 30 + charge 45 − closing 35 = 40.
Net cash from operating activities: 202 − 12 − 40 = 150.
Property, plant and equipment additions: opening 500 + additions − disposal 40 − depreciation 70 = closing 640, so additions are 250.
Disposal proceeds: carrying amount 40 + profit 10 = 50.
Investing activities: (250) + 50 = (200).
Financing activities: share issue 380 − 300 = 80; loan repaid 150 − 100 = (50); dividends paid (40). Net financing is 80 − 50 − 40 = (10).
Check dividends: opening retained earnings 150 + profit after tax (160 − 45 = 115) − closing 225 = 40. This agrees.
Net change in cash: 150 − 200 − 10 = (60). Opening cash 20 less 60 gives closing (40), which agrees to the overdraft.

Answer: Net cash from operating activities is 150, net cash used in investing activities is (200), and net cash used in financing activities is (10). Cash and cash equivalents fall by 60, from 20 to (40).

Exam tips

Show the reconciliation and every working on your answer. In constructed response questions you can earn marks for method even if one figure is wrong.
In Section A and B, read what the question asks for. One question may need only tax paid or cash generated from operations, so do not build the whole statement.
Always finish with the check: net change in cash must equal the movement in cash and cash equivalents. It catches most errors quickly.
Write down the accounting policy choices that IAS 7 allows (interest and dividends). Apply your choice consistently and label the line clearly.
Look for non-cash traps in the question: revaluations, bonus issues, assets acquired on lease and accruals. Exclude them from the cash line.

Practice questions from Preparation of single entity financial statements

Statement of Cash Flows under IAS 7 in other exams

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

Statement of Cash Flows under IAS 7: frequently asked questions

What is the difference between the direct and indirect method of cash flows?

Both give the same net cash from operating activities. The direct method lists gross cash receipts from customers and payments to suppliers and employees. The indirect method starts with profit before tax and adjusts for non-cash items and working capital changes. IAS 7 encourages the direct method, but the indirect method is what ACCA FR usually examines.

Why do we add back depreciation in the cash flow statement?

Depreciation reduces profit but involves no cash outflow. The cash was spent when the asset was bought, which appears in investing activities. Adding it back removes a non-cash charge from profit.

Where do interest and dividends go in the statement of cash flows?

IAS 7 lets an entity classify interest paid and dividends paid as operating or financing, and interest and dividends received as operating or investing. Choose one treatment and apply it consistently. Follow any instruction in the question.

How do I calculate tax paid for the cash flow statement?

Use a tax account. Opening tax liability plus the tax charge for the year, less the closing liability, gives the tax paid. If deferred tax is included in the charge, include the deferred tax balances in the same working.