IAS 7 Statement of Cash Flows: Format, Cash Equivalents and the Indirect Method

A company can show a profit and still run out of cash. Profit includes sales not yet collected and expenses, such as depreciation, that never leave the bank, while cash includes loans received and assets bought that never touch profit. The statement of cash flows answers a different question from the statement of profit or loss: where did the cash come from during the year, and where did it go.

International Accounting Standard (IAS) 7 Statement of Cash Flows sets out its content. This topic covers its purpose, the definition of cash and cash equivalents, the three headings, the layout, and the indirect method for operating activities, including the figures that come from comparing opening and closing balances. The next topic covers working capital adjustments and the direct method.

The topic is examined directly. In May Diet, 2025, Question 1 asked for a statement of cash flows by the indirect method (20 marks) and for the meaning of cash and cash equivalents with two examples (4 marks). November Diet, 2024, Questions 3 and 4 asked for consolidated and single-entity statements, and November Diet, 2025, Question 3(c) asked for cash flows from operating activities by the indirect method (5 marks). Read revaluation, tax, share issues and held-for-sale items first.

Purpose and the three headings

The statement of cash flows is part of a complete set of financial statements. It helps users evaluate changes in net assets, financial structure (including liquidity and solvency), the ability to affect the amount and timing of cash flows, and the ability to generate cash.

Cash flows are not affected by differences in accounting policies, so they are more comparable than profit. Historical cash flows are a useful guide to the amount, timing and certainty of future ones.

• Operating activities: the principal revenue-producing activities and other activities that are not investing or financing, such as cash receipts from customers and payments to suppliers and employees.
• Investing activities: acquisition and disposal of long-term assets and other investments not in cash equivalents, such as purchases and sales of property, plant and equipment and intangible assets, and investments in other entities.
• Financing activities: activities that change the size and composition of the contributed equity and borrowings, such as proceeds from share issues, loans received and repaid, and lease payments of principal.

A single transaction may include more than one type of cash flow, such as a loan repayment of capital and interest, which are classified separately. The three totals explain the net increase or decrease in cash and cash equivalents between the opening and closing balances.

Cash and cash equivalents

Cash comprises 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. They are held to meet short-term cash commitments rather than for investment. An investment normally qualifies only if it has a short maturity of, say, three months or less from the date of acquisition.

Examples are a bank deposit that needs a period of notice and short-term government bills. Movements between cash and cash equivalents are not cash flows. Bank overdrafts repayable on demand that form an integral part of cash management are included in cash and cash equivalents. Other bank borrowing is a financing activity.

The entity discloses the components of cash and cash equivalents and a reconciliation to the statement of financial position. Any significant balances that it holds but cannot use, with a commentary.

The layout

IAS 7 does not fix an exact format but gives an illustrative layout. The three sections are totalled, the net increase or decrease is shown, the opening cash and cash equivalents are added. The closing figure must agree to the statement of financial position. Interest and dividends received and paid are classified consistently from period to period.

Under IAS 7 as it stands for periods before 2027 an entity may classify interest paid and dividends paid as operating or financing, and interest and dividends received as operating or investing. Under International Financial Reporting Standard (IFRS) 18, for periods beginning on or after 1 January 2027, the indirect method starts from operating profit and these options are removed.

Operating activities: the indirect method

The indirect method reconciles profit to cash from operations. The steps are:

1. Start with profit before tax.
2. Add back non-cash expenses: depreciation, amortisation, impairment losses, and losses on disposal; deduct profits on disposal, because the whole proceeds are shown under investing.
3. Add back finance costs and deduct investment income (interest and dividends received) if they are shown under financing or investing.
4. Adjust for changes in working capital: an increase in receivables or inventory reduces cash, and an increase in payables increases it (the next topic).
5. The result is cash generated from operations. Deduct interest paid (if operating) and tax paid to reach net cash from operating activities.

For example, profit before tax is ₦140 million, finance costs ₦12 million, depreciation ₦35 million, amortisation ₦5 million, profit on disposal of equipment ₦8 million and investment income ₦4 million. Before working capital changes: ₦140m + ₦12m + ₦35m + ₦5m − ₦8m − ₦4m = ₦180 million.

Interest, tax and dividends paid

The cash paid differs from the charge in the statement of profit or loss by the change in the related balance in the statement of financial position.

• Interest paid. = interest expense + opening interest payable − closing interest payable.
  With an expense of ₦12m, opening payable ₦3m and closing ₦4m: ₦12m + ₦3m − ₦4m = ₦11 million.
• Tax paid. = opening tax liability + tax charge − closing tax liability, including deferred tax in the liability and the charge.
  With opening ₦20m, charge ₦38m and closing ₦25m: ₦20m + ₦38m − ₦25m = ₦33 million.
  Tax charged to other comprehensive income (for example on a revaluation) is excluded from the cash calculation.
• Dividends paid. = opening retained earnings + profit for the year − closing retained earnings (if there are no other movements).
  With opening ₦150m, profit ₦101m and closing ₦190m: ₦150m + ₦101m − ₦190m = ₦61 million.

These workings are the main source of method marks. Always show them separately and refer to them in the statement.

The three sections in more detail

Operating activities are the entity’s normal trading activities. The statement distinguishes cash generated from operations, which is cash from sales less cash payments for operating costs, from net cash from operating activities, which is that figure less interest paid (if classified here) and tax paid on profits.

Examples are cash receipts from the sale of goods and services, from royalties, fees and commissions, cash payments to suppliers and employees, and payments or refunds of income tax unless they can be specifically identified with investing or financing. Cash paid to make or acquire assets held for rental to others and then held for sale, and the later receipts, are also operating.

The amount is a key indicator of whether operations generate enough cash to function without outside finance, and it is a basis for forecasting.

Investing activities are the acquisition and disposal of long-term assets and other investments not in cash equivalents. They include cash paid to acquire property, plant and equipment, intangibles (including capitalised development costs and self-constructed assets) and equity or debt instruments of other entities; cash received from selling them; and loans made to, and repaid by, other parties (other than by a financial institution, whose lending is operating).

They show how much has been spent on resources intended to generate future income. Financing activities are those that change the size and composition of contributed equity and borrowings: proceeds of issuing shares, debentures, loans and bonds, payments to buy back or redeem shares, and repayments of amounts borrowed. They help predict claims on future cash flows by providers of capital.

Gross or net

Major classes of investing and financing cash flows are reported gross: receipts and payments are shown separately, even with the same party. Net reporting is allowed only for cash receipts and payments on behalf of customers when they reflect the customer’s activities (rent collected for property owners and passed on), and for items with quick turnover, large amounts and short maturities.

Non-cash items and accrual-based figures

Depreciation and amortisation are expenses with no cash payment, so they are added back. Gains and losses on disposal are not cash flows either: the gain or loss is the proceeds less the carrying amount, and its effect is removed from profit by deducting a gain or adding back a loss. The cash proceeds are shown once, under investing activities.

For example, equipment cost ₦90 million with accumulated depreciation of ₦51 million, so the carrying amount is ₦39 million. It is sold for ₦55 million, a gain of ₦16 million. The ₦16 million is deducted in the operating reconciliation and the ₦55 million is an investing inflow.

The same rule works for any liability that has an expense in profit or loss: cash paid = opening liability + charge for the year − closing liability. It does not matter whether the liability is interest, tax, a warranty provision, a gratuity or a bonus pool. A warranty provision of ₦10 million at the start, a charge of ₦15 million and ₦12 million at the end implies payments of ₦10m + ₦15m − ₦12m = ₦13 million.

Interest of ₦8 million charged, with a liability of ₦5 million at the start and ₦6 million at the end, means ₦7 million paid. Tax is not adjusted in the reconciliation because the starting point is profit before tax; tax paid is deducted separately. With a liability of ₦28 million at the start, a charge of ₦32 million and a liability of ₦30 million at the end, tax paid is ₦30 million.

Deferred tax

A deferred tax liability is an amount the company expects to pay in future, so it has had no cash effect yet. A movement on it is a double entry to tax expense and does not involve cash. The usual way to deal with it is to include the deferred tax balance with the current tax liability and the whole tax charge (current plus deferred) in the same working.

Tax charged or credited to other comprehensive income is left out of the cash calculation.

A complete statement

A company has profit before tax of ₦120 million, depreciation and amortisation of ₦30 million, finance costs of ₦8 million and a gain on disposal of ₦16 million. Receivables rose by ₦9 million, inventory fell by ₦4 million and payables rose by ₦6 million. Tax paid was ₦30 million and interest paid ₦7 million. It bought property, plant and equipment for ₦60 million, sold equipment for ₦55 million and bought investments for ₦10 million.

It issued shares for ₦40 million, received a new loan of ₦25 million, repaid a loan of ₦20 million and paid dividends of ₦35 million. Cash and cash equivalents were ₦12 million at the start.

Investing and financing sections are the same whether the direct or the indirect method is used. Only the way of reaching cash generated from operations differs.

Disclosures

• Components of cash and cash equivalents and a reconciliation to the statement of financial position.
• Significant balances held but not available for use, for example in a subsidiary restricted by loan covenants or exchange controls, with a commentary by management.
• Non-cash investing and financing transactions, such as buying an asset by issuing shares, or by a lease, are excluded from the statement but disclosed elsewhere in the statements.
• Changes in liabilities arising from financing activities, showing cash flows and non-cash changes. For example, a loan of ₦60 million at the start, new borrowing of ₦25 million and repayment of ₦20 million gives ₦65 million at the end.

Why profit and cash differ

Profit follows the accruals concept: sales are recognised when made and expenses when incurred. Cash follows payment. So profit differs from cash because of depreciation (no cash), credit sales and purchases (timing), asset purchases and sales (investing, not profit), loans and share issues (financing, not profit) and dividends paid. A profitable company can run out of cash if receivables or inventory grow faster than it collects.

The ideas in more depth

Why add back depreciation

Depreciation reduced profit but no cash left the business. The indirect method starts from profit, so it must put back what was deducted without a payment. It is not a source of cash, only a correction of the starting figure.

Why profit on disposal is deducted

The sale proceeds are a single investing inflow. If the profit were left in operating cash flow as well, the same cash would be counted twice.

Sources and references

• IAS 7 Statement of Cash Flows: cash and cash equivalents, the classification of cash flows, and the indirect method; IFRS 18 for the consequential amendments from 2027.

These points are stated as at 5 November 2026.

Worked examples

1. Add back.
   ₦140m + ₦12m + ₦35m + ₦5m = ₦192m.
2. Deduct.
   ₦192m − ₦8m − ₦4m = ₦180m.

1. Interest paid.
   ₦12m + ₦3m − ₦4m = ₦11m.
2. Tax paid.
   ₦20m + ₦38m − ₦25m = ₦33m.

1. Dividends.
   ₦150m + ₦101m − ₦190m = ₦61m.

1. Carrying amount.
   ₦90m − ₦51m = ₦39m; gain ₦55m − ₦39m = ₦16m, deducted from operating profit; ₦55m shown under investing.
2. Warranty cash paid.
   ₦10m + ₦15m − ₦12m = ₦13m.

How to answer in the exam

• Work out the paid figures first (interest, tax, dividends) in separate workings.
• Start at profit before tax, add back non-cash items, remove items shown elsewhere, then adjust working capital.
• Check the end. Opening cash and cash equivalents plus the net movement must equal the closing figure in the statement of financial position.
• Define cash and cash equivalents with two examples when asked.

Common mistakes in the exam

• Adding back depreciation but forgetting the loss or profit on disposal.
• Using the tax charge as the tax paid.
• Treating the whole movement in retained earnings as dividends when other items affect it.
• Leaving finance costs in operating cash flow and also showing interest paid.
• Excluding an overdraft repayable on demand from cash and cash equivalents.
• Showing movements between cash and cash equivalents as cash flows.

Quick revision

• Three sections: operating, investing, financing. Closing cash agrees to the statement of financial position.
• Cash equivalents: short-term (three months or less), highly liquid, insignificant risk of changes in value.
• Indirect method: profit before tax, add back non-cash items and finance costs, deduct investment income and profits on disposal, working capital, then paid figures.
• Paid = charge + opening balance − closing balance.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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