Statement of cashflows

A statement of cash flows explains why the cash (and cash equivalents) balance changed during the year — answering the question 'the company made a profit, so why has the cash not increased by the same amount?'

Cash flows are classified into three activities (IAS 7):

• Operating activities — cash from the main trading operations (the day-to-day business).
• Investing activities — buying and selling non-current assets and investments.
• Financing activities — raising and repaying long-term finance: issuing shares, raising/repaying loans, paying dividends.

The three sub-totals add up to the net increase or decrease in cash, which is then reconciled to the opening and closing cash balances. The statement is important because profit is not cash — a profitable company can still run out of cash, and this statement reveals that.

The operating section is usually prepared by the indirect method, starting from profit before tax and adjusting:

Step 1 — non-cash items:

• add back depreciation (a non-cash expense);
• add back finance costs (interest is shown separately later);
• add back any loss on disposal (or deduct a profit on disposal) of non-current assets.

Step 2 — working-capital changes:

• an increase in inventory or receivables is a use of cash (deduct);
• a decrease in them releases cash (add);
• an increase in payables is a source of cash (add); a decrease (deduct).

This gives cash generated from operations. Then:

• less interest paid and less tax paid → net cash from operating activities.

$\text{Working-capital rule: } \text{asset} \uparrow = \text{cash} \downarrow;\; \text{liability} \uparrow = \text{cash} \uparrow$

Investing activities — cash flows from non-current assets and investments:

• purchase of non-current assets — a cash outflow (negative);
• proceeds from selling non-current assets — a cash inflow (the actual sale proceeds, not the profit);
• interest/dividends received (if classified here).

Financing activities — cash flows from long-term finance:

• proceeds from issuing shares (including any premium) — an inflow;
• proceeds from a new loan/debenture — an inflow; repaying a loan — an outflow;
• dividends paid — an outflow (the actual cash dividend paid in the year).

Each section is sub-totalled. Note interest paid, tax paid and dividends paid are the actual cash amounts, which may differ from the charges in the profit statement if there are opening/closing payables (e.g. tax owing).

Finally, add the three sub-totals:

$\text{Net change in cash} = \text{Operating} + \text{Investing} + \text{Financing}$

Then reconcile:

	$
Net increase/(decrease) in cash and cash equivalents	X/(X)
add Cash and cash equivalents at the start	X
= Cash and cash equivalents at the end	XX

The closing figure must agree with the cash and bank in the statement of financial position — a key check.

Why it matters (interpretation): a company can be profitable but cash-poor (e.g. profits tied up in higher inventory and receivables, or spent on new assets). The statement shows whether cash came from operations (healthy/sustainable) or from loans/share issues (one-off), and whether it is being reinvested or paid out. This makes it a key tool for assessing liquidity and cash management.