## Learning Outcomes

After reading this article, you will be able to classify and explain the three main activities in a statement of cash flows per IAS 7: operating, investing, and financing. You will know how to identify the typical cash flows in each category, describe their significance for assessing performance and liquidity, and recognize how these classifications appear in ACCA Financial Reporting (FR) questions. Practical application and preparation tips are included.

## ACCA Financial Reporting (FR) Syllabus

For ACCA Financial Reporting (FR), you are required to understand the structure and content of a statement of cash flows and distinguish between its components. In particular, make sure you revise:

- The classifications of cash flows into operating, investing, and financing activities per IAS 7
- The types and examples of transactions to be allocated to each activity
- The purpose and importance of the statement of cash flows for exam analysis and interpretation
- Identification of non-cash transactions and the indirect method for 'cash generated from operations'
- Adjustments for unusual, one-off, or exam-style scenarios (e.g. lease payments, interest, or tax)

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. Which of the following is classified as a financing activity under IAS 7?
   a) Purchase of inventory
   b) Payment of a lease liability
   c) Cash received from customers
   d) Cash received from sale of equipment

2. True or false? Cash flows relating to interest paid may be classified as either operating or financing activities under IAS 7, depending on the entity’s accounting policy.

3. List three typical examples of investing activities in the statement of cash flows.

4. Briefly explain the difference between 'cash equivalents' and 'cash' as defined by IAS 7.

## Introduction

The statement of cash flows is a required primary statement for published accounts under IAS 7. It summarises all cash inflows and outflows in an entity during a period, grouped into operating, investing, and financing activities. This structure allows users to assess not just how much profit a business reports, but its actual liquidity, solvency, and its ability to generate cash. For ACCA FR, you are expected to classify cash flows correctly, recognise typical items in each section, and interpret their impact on the business.

> **Key Term: cash flows**
> Inflows and outflows of cash and cash equivalents, as defined by IAS 7, arising from transactions and events within the period.
> **Key Term: cash equivalents**
> Highly liquid short-term investments that are readily convertible into known amounts of cash and subject to insignificant risk of value changes.
> **Key Term: operating activities**
> The principal revenue-producing activities of an entity and other activities that are not investing or financing. Usually reconciled via the statement of profit or loss.
> **Key Term: investing activities**
> The acquisition and disposal of non-current assets and other investments not included in cash equivalents.
> **Key Term: financing activities**
> Activities that result in changes in the equity and borrowings of the entity, such as the issue or repayment of shares and debt.

### Classification of Cash Flows — IAS 7

IAS 7 requires every cash flow to be classified as either operating, investing, or financing:

![Indirect-method reconciliation from profit before tax to cash generated from operations, including non-cash adjustments, working capital movements, interest paid, and tax paid.](https://static.pastpaperhero.com/images/acca-fr-statement-of-cash-flows-ias-7-operating-investing-and-financing-activities_00.png)

_Indirect-method operating cash flow reconciles profit before tax to cash generated from operations, then identifies interest paid and tax paid separately._

### Operating Activities

Operating activities relate to transactions forming part of normal business trading, i.e. revenue, expenses, and working capital. These are the core day-to-day cash-generating actions.

- Examples: receipts from customers, payments to suppliers and staff, cash tax payments, interest paid (accounting policy choice may affect this), and cash-related changes in working capital items.

### Investing Activities

Investing activities are the acquisition and disposal of long-term assets and other investments. These cash flows show how the entity is securing or disposing of resources for future growth.

- Examples: purchase or sale of property, plant and equipment (PPE), proceeds from sale of financial investments, or loans made to other parties.

### Financing Activities

Financing activities signal transactions with equity investors and lenders, affecting the company’s capital structure.

- Examples: proceeds from issuing shares or loans, repayments of borrowings, payment of lease liabilities, and dividends paid.

### Worked Example 1.1

A company buys new machinery for \$100,000, pays \$20,000 as a lease liability, takes out a new bank loan of \$50,000, and receives \$2,000 in interest from a government bond. Classify each cash flow.

> **Answer:**
>
> - Machinery purchase: **Investing activity** (acquisition of non-current assets)
> - Lease liability payment: **Financing activity** (outflow related to capital funding)
> - New bank loan proceeds: **Financing activity** (new capital inflow)
> - Interest received: **Investing activity** (return on investments)

### How to Identify Cash Flows in Exam Scenarios

When classifying specific cash flows, consider:

- Is this transaction part of everyday trading? → _Operating_
- Does this cash flow concern buying or selling long-term resources? → _Investing_
- Is the transaction changing the entity’s debt/equity? → _Financing_

> **Exam Warning:**
> Lease payments should be split: the interest element is usually an operating activity, while repayment of principal is classified as financing. However, check if the question specifies how to treat these flows. Always follow exam instructions for classification.

### Cash and Cash Equivalents

IAS 7 makes a specific distinction between 'cash' and 'cash equivalents'.

- 'Cash' means bank balances or physical currency.
- 'Cash equivalents' means short-term, highly liquid investments—such as treasury bills or money market funds—that are quickly convertible and highly secure.

This definition is essential for the opening and closing "cash and cash equivalents" reconciliation on the statement.

> **Revision Tip:**
> In exam calculations, check if any short-term investments are included in the question's definition of cash equivalents.

### Non-Cash Transactions

Not all significant financing and investing activities involve immediate cash movement. These transactions are excluded from the main statement of cash flows but must be disclosed elsewhere in the financial statements.

- Example: purchasing an asset by issuing shares is not a cash transaction.

## Summary

IAS 7 groups cash flows into operating, investing, and financing activities to help users assess an entity’s liquidity and financial flexibility. Accurate classification of these cash flows is required both in ACCA FR calculations and for exam interpretation questions.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- Explain the purpose and classification requirements of a statement of cash flows under IAS 7
- Identify typical operating, investing, and financing activities and provide suitable examples for each
- Define 'cash equivalents’ and explain their significance for cash flow statements
- Recognise and classify non-cash transactions for appropriate disclosure
- Understand the impact of correct cash flow classification in accrual-to-cash reconciliations and ACCA exam adjustments

## Key Terms and Concepts

- cash flows
- cash equivalents
- operating activities
- investing activities
- financing activities


Statement of cash flows (IAS 7) - Operating, investing, and financing activities