Statement of Cash Flows (IAS 7)
Performance
Statement of Cash Flows (IAS 7)
Syllabus tag: KASNEB CPA | Intermediate Level | CA23 Financial Reporting and Analysis | Topic 8 Statement of Cash Flows
Lesson objectives
By the end of this topic, you will be able to:
- Classify cash flows as operating, investing or financing
- Prepare the operating section by the indirect method
- Adjust for non-cash items and working capital movements
- Compute tax paid and dividends paid from opening and closing balances
- Explain why a profitable company can run short of cash
Why this matters
Profit is an opinion; cash is a fact. The income statement contains estimates — depreciation, provisions, accruals — while the cash flow statement records money that actually moved. It is the hardest statement to manipulate, which is why analysts read it first.
One company throughout
Simba Ltd, year ended 31 December.
| This year | Last year | |
|---|---|---|
| Inventory | 6,400,000 | 5,500,000 |
| Receivables | 7,200,000 | 6,300,000 |
| Payables | 4,800,000 | 4,100,000 |
| Tax payable | 1,800,000 | 1,600,000 |
Profit before tax KES 8,400,000. Depreciation KES 2,600,000. Loss on disposal KES 300,000. Interest expense KES 700,000. Tax charge KES 2,100,000. Opening cash KES 1,450,000.
The three classifications
Operating — the trading activity itself. Receipts from customers, payments to suppliers and staff, tax paid.
Investing — buying and selling non-current assets and investments.
Financing — dealings with providers of capital: share issues, loans raised and repaid, dividends paid.
The classification of interest and dividends is a choice IAS 7 permits, but it must be applied consistently and disclosed.
The indirect method
Start with profit before tax and work backwards to cash.
| KES | |
|---|---|
| Profit before tax | 8,400,000 |
| Add depreciation | 2,600,000 |
| Add loss on disposal | 300,000 |
| Add interest expense | 700,000 |
| Operating profit before working capital changes | 12,000,000 |
| Increase in inventory | (900,000) |
| Increase in receivables | (900,000) |
| Increase in payables | 700,000 |
| Cash generated from operations | 10,900,000 |
| Interest paid | (700,000) |
| Tax paid | (1,900,000) |
| Net cash from operating activities | 8,300,000 |
Three adjustments worth understanding rather than memorising.
Depreciation is added back because it reduced profit without any cash leaving. It is not a source of cash — it is the removal of something that was never a cash outflow.
The loss on disposal is added back because the whole proceeds appear under investing. Leaving the loss in operating would count it twice.
Interest is added back and then shown as paid, so that the figure for cash generated from operations is free of financing effects and comparable between companies with different gearing.
Working capital: the direction of the adjustment
| Movement | Effect on cash |
|---|---|
| Inventory rises | Deduct — cash is tied up in stock |
| Receivables rise | Deduct — sales made but not yet collected |
| Payables rise | Add — goods received but not yet paid for |
The rule underneath: an increase in an asset uses cash; an increase in a liability provides it. Everything else follows from that.
Computing tax paid
The tax charge in the income statement is not the tax paid. Reconstruct the account:
Tax paid = Opening balance + Charge for the year − Closing balance
= 1,600,000 + 2,100,000 − 1,800,000 = KES 1,900,000
The same method gives dividends paid, interest paid, and any other figure where an opening balance, a charge and a closing balance are known.
:::checkpoint A company reports a tax charge of KES 2,100,000 and pays KES 1,900,000. Where has the remaining 200,000 gone, and on which statement will you find it? :::
Completing the statement
| KES | |
|---|---|
| Net cash from operating activities | 8,300,000 |
| Purchase of non-current assets | (9,400,000) |
| Proceeds from disposal | 1,500,000 |
| Net cash used in investing | (7,900,000) |
| Proceeds from share issue | 4,000,000 |
| Loan repaid | (2,500,000) |
| Dividends paid | (1,800,000) |
| Net cash from financing | (300,000) |
| Net increase in cash | 100,000 |
| Opening cash | 1,450,000 |
| Closing cash | 1,550,000 |
The closing figure must agree with the cash in the statement of financial position. If it does not, the statement is wrong somewhere.
Reading the statement
This company made a profit before tax of 8,400,000 and its cash rose by 100,000. That is not a contradiction — it invested 7,900,000 net in new assets and returned 1,800,000 to shareholders.
The pattern to watch for is different: cash generated from operations falling while profit rises. That usually means receivables or inventory are building — sales made to customers who are not paying, or stock that is not selling. It is the earliest reliable warning of overtrading, and it appears in the cash flow statement long before it appears anywhere else.
:::checkpoint Over three years a company reports rising profit while cash generated from operations falls each year. Give the two most likely explanations and name the figures you would examine to distinguish them. :::