The International Accounting Standard known today as IAS 7, Statement of Cash Flows, exists to ensure that companies share clear and structured information about how money moves in and out of the business. The standard focuses on the movement of cash and items that are almost as liquid as cash. Over time, this standard has been revised and updated, particularly as wider changes occurred across the IFRS landscape, but the core idea remains consistent: users of financial reports should be able to understand how an organisation generates money, spends money, and manages its overall liquidity.
Understanding cash activity helps investors, lenders, analysts, and even employees evaluate a company’s financial health beyond just profit figures. While a business might report earnings on paper, cash flow information shows whether the organisation actually has money available to run operations, expand, and settle obligations.
Why IAS 7 Exists
IAS 7 requires organisations to disclose the historical movement of cash and cash equivalents by grouping these movements into operating, investing, and financing activities. The emphasis on history is important because past behaviour gives insights into the likely future pattern of cash generation. Unlike other parts of financial reporting that focus on profit, assets, or equity, this standard is designed to highlight liquidity—the very real ability of a business to meet its obligations when they fall due.
Decision-makers rely heavily on this information. When choosing whether to buy shares, extend credit, or approve loans, users need more than theoretical profit measures. They need to see how frequently the business brings in cash, whether that cash is reliable, and whether significant outflows are creating pressure that might not be obvious from the income statement alone.
When IAS 7 Must Be Applied
The rules of IAS 7 apply to every organisation that prepares financial statements under IFRS. Regardless of size, sector, or corporate structure, every reporting entity must include a statement of cash flows as part of their annual financial reporting package. The requirement exists because all businesses use cash in comparable ways—even if their operations differ widely. A manufacturing company or a bank might earn revenue using entirely different activities, but both still pay employees, settle loans, and invest in assets.
This requirement replaced an even older standard focused on changes in financial position, reflecting the evolution in accounting practice and the increased emphasis on direct cash-related information.
Why Cash Flow Information Matters
Users of accounting information want to understand how a company’s net assets change, how solvent it is, and how it manages its cash-based obligations. The cash flow statement improves comparability between companies because it ignores accounting policies that might differ in the calculation of profit. If revenue recognition or depreciation methods vary, those differences influence profit but do not necessarily affect cash movement.
Historical patterns of cash movements are also used to predict future performance. If a business consistently generates strong operating cash flows, observers may feel confident that future cash flows will remain solid. Likewise, if a company often struggles to generate cash from operations, users may question whether profit figures represent real economic strength.
Important Definitions
To apply IAS 7 effectively, a few basic terms are essential. Cash includes money held physically and bank deposits available immediately. Cash equivalents are extremely short-term investments, usually maturing within a few months, which can be converted to cash with almost no risk of losing value. Cash flows are simply inflows and outflows of these balances.
Operating activities relate to the everyday revenue-generating side of a business. Investing activities involve buying and selling long-term assets and certain types of investments. Financing activities involve transactions that change equity or borrowings. Understanding these categories helps users interpret the significance of each cash movement.
Cash and Cash Equivalents Explained
Some investments are so close to cash that they are treated as cash equivalents. They must be readily convertible to known amounts of cash and present very little risk of value change. Generally, only investments with original maturities of about three months qualify. Ordinary shares will not normally be considered cash equivalents, unless they are about to mature or be redeemed.
In some circumstances, overdrafts repayable on demand may also be treated as part of cash management, particularly when the balance regularly moves from positive to negative. However, normal bank loans are regarded as financing cash flows rather than part of cash and cash equivalents.
Presenting the Statement
IAS 7 requires companies to classify cash flows according to operating, investing, and financing activities. Reporting by category helps readers assess the relationship between different types of business activity and overall liquidity. For example, if a company consistently generates positive operating cash flow but spends heavily on investments, users understand that expansion is being funded internally.
Some transactions include multiple elements. If a loan repayment includes both interest and principal, the interest portion may be treated as operating activity, while the capital repayment reflects financing activity.
Read More: The Art of Managing Cash Flow Effectively
Operating Activity Cash Flows
Operating activities reflect everyday transactions, such as selling products, providing services, paying suppliers, and compensating employees. Large and regular movements usually fall into this category. Because these activities relate to core operations, they provide the strongest evidence of ongoing business sustainability.
Certain income tax payments also fall under operating cash flows unless directly connected to financing or investing decisions. Even when profits include gains or losses from selling assets, the associated cash flows are treated differently, reinforcing the separation between operating performance and investing decisions.
Investing Activity Cash Flows
Investing activities represent the use of cash for long-term benefit. Purchasing machinery, acquiring intangible assets, or buying shares in other companies would all fall into this category. When those assets are later sold, the resulting inflows also count as investing cash flows.
IAS 7 places importance on distinguishing between spending that will expand operational capacity and spending that simply maintains existing capacity. This distinction becomes relevant in voluntary disclosures that allow readers to understand whether spending today supports future growth or merely preserves current ability.
Financing Activity Cash Flows
Financing activities explain how an entity raises capital or repays it. Issuing shares, drawing loans, repaying borrowings, and paying dividends are common examples. These movements show how a business changes its capital structure. Users can assess whether the organisation relies heavily on external financing or whether operations themselves fund most activities.
In the context of lease liabilities under newer IFRS standards, payments that reduce a lease liability are treated as financing activities. This approach aligns with the idea that lease obligations represent borrowing-like arrangements.
Direct and Indirect Reporting Methods
IAS 7 allows two approaches for presenting operating cash flows. The direct method lists major cash receipts and payments explicitly. The indirect method starts with reported profit and adjusts for non-cash transactions, timing differences, and items connected with investing or financing.
Although both methods are acceptable, the direct method offers clearer insights into gross movements of cash and can help users forecast future cash flows more accurately. Yet many companies still prefer the indirect method because it is easier to prepare from existing accounting data.
Other Key Areas of Reporting
Cash movements may sometimes be shown on a net basis, especially when transactions occur rapidly, involve large volumes, or reflect activity on behalf of customers rather than the business itself. Foreign currency cash flows must be converted into the reporting currency using appropriate exchange rates at the dates the cash flows occur.
Interest and dividend cash flows must be disclosed separately, and companies should apply their classification consistently each period. Income tax cash flows are usually operating activities, although exceptions apply when they relate to investing or financing transactions.
Dealing with Subsidiaries, Ownership Changes, and Non-Cash Transactions
When businesses acquire or lose control of subsidiaries, the related cash flows are reported as investing activities and presented separately from normal operational cash flows. IAS 7 requires additional disclosure so users understand how much cash truly changed hands and what assets and liabilities were obtained.
Not all investing or financing transactions involve cash. If assets are acquired through leases, or debt is converted into shares, these events must still be disclosed even though no cash flowed at the time. Such disclosure helps users evaluate how financing decisions affect the organisation’s structure.
Required Disclosures and Effective Use of Information
Companies must also disclose components of cash and cash equivalents and reconcile amounts appearing in the cash flow statement with those shown on the statement of financial position. Additional commentary is encouraged, particularly when certain cash balances cannot be accessed because of legal or practical restrictions.
IAS 7 has evolved through numerous amendments, reflecting the growing complexity of global financial reporting and the desire for more transparent information. Despite these changes, the fundamental goal remains the same: to provide a clear view of how cash moves through an organisation, allowing users to evaluate liquidity, solvency, and financial resilience with greater confidence.
IAS 7 – Frequently Asked Questions
What Is The Main Purpose Of IAS 7?
IAS 7 aims to show how cash moves in and out of a business by requiring a statement of cash flows. This helps users assess a company’s ability to generate cash, pay its bills, invest, and reward its investors.
Why Is Cash Flow Information So Important?
Cash flow information goes beyond paper profits. It reveals whether a company can actually pay suppliers, salaries, interest, and taxes, and whether it has enough cash to grow or survive tough periods.
What Are Cash And Cash Equivalents?
Cash includes physical money and demand deposits. Cash equivalents are very short-term, low-risk investments that can be quickly turned into cash—typically with original maturities of three months or less.
What Are The Three Main Categories Of Cash Flows?
IAS 7 groups cash flows into operating, investing, and financing activities. This structure helps users see how day-to-day operations, long-term investments, and funding decisions each affect the cash position.
What Counts As Operating Activities?
Operating activities are the core, day-to-day activities that generate revenue. They include cash from sales, payments to suppliers and employees, and most income tax payments related to normal operations.
What Counts As Investing Activities?
Investing activities involve buying and selling long-term assets and certain investments. Purchasing machinery, buildings, or shares in other companies, and later selling them, falls into this category.
What Counts As Financing Activities?
Financing activities show how the business is funded and how that funding is repaid. Issuing shares, taking out loans, repaying borrowings, and paying dividends are all typical financing cash flows.
What Is The Difference Between The Direct And Indirect Method?
Under the direct method, the company shows major cash receipts and payments directly. The indirect method starts from profit and adjusts for non-cash items and timing differences. IAS 7 allows both, but encourages the direct method.
How Does IAS 7 Treat Foreign Currency Cash Flows?
Foreign currency cash flows are translated into the functional currency using exchange rates at the dates of the cash flows (or a reasonable average). Exchange rate gains and losses themselves are not cash flows but are shown separately in the cash flow statement.
Are Non-Cash Transactions Included In The Cash Flow Statement?
No. Transactions that do not involve actual cash, such as converting debt to equity or acquiring assets via a lease, are excluded from the statement of cash flows. However, they must be disclosed elsewhere because they still affect the company’s financial structure.
How Are Changes In Financing Liabilities Disclosed?
IAS 7 requires companies to explain changes in liabilities arising from financing activities, including both cash and non-cash changes. A common way is to show a reconciliation from the opening to closing balance of these liabilities.
What Extra Disclosures Might Help Users Understand Cash Flows Better?
Companies are encouraged to explain restricted cash balances, unused borrowing facilities, and cash flows relating to different segments. This extra context helps users judge liquidity, growth investment, and how cash is distributed across the business.