1. Why a Cash Flow Statement — Objective and Scope
Profit or loss is built on accrual accounting — revenue and expenses are recognised when earned or incurred, not necessarily when cash actually moves. A profitable company can run out of cash; a company with a net loss can be cash-generative. IND AS 7 requires every entity to present a statement of cash flows as an integral part of its financial statements, classifying cash flows during the period as operating, investing or financing, so users can assess the entity's ability to generate cash and its need to use it.
2. 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 — held for the purpose of meeting short-term cash commitments rather than for investment.
An investment normally qualifies as a cash equivalent only if it has a short maturity, typically three months or less from the date of acquisition — not three months from the reporting date. Equity investments are generally excluded from cash equivalents, unless they are, in substance, cash equivalents (e.g. preference shares acquired shortly before their specified redemption date, with a fixed and known redemption amount).
Bank overdrafts repayable on demand and forming an integral part of an entity's cash management are included as a component of cash and cash equivalents (i.e. shown as a negative), even though they are technically a liability.
3. The Three Categories — Operating, Investing, Financing
| Category | Definition | Typical items |
|---|---|---|
| Operating | The principal revenue-producing activities of the entity, and other activities that are not investing or financing | Cash from customers; cash paid to suppliers and employees; interest paid on trade payables (if classified operating); income taxes paid |
| Investing | Acquisition and disposal of long-term assets and other investments not included in cash equivalents | Purchase/sale of PP&E and intangibles; purchase/sale of investments in other entities; loans made to other parties |
| Financing | Activities that change the size and composition of the entity's equity and borrowings | Proceeds from issuing shares; proceeds and repayments of borrowings; dividends paid; principal payments on a lease liability |
Under IND AS 116, the principal portion of lease payments is a financing cash outflow, while the interest portion follows the entity's chosen policy for interest paid (operating or financing) — payments relating to short-term leases, low-value asset leases, and variable lease payments not included in the lease liability remain operating cash outflows.
4. Direct Method vs Indirect Method
Direct method
Discloses major classes of gross cash receipts and gross cash payments — cash received from customers, cash paid to suppliers, cash paid to and on behalf of employees, and so on. IND AS 7 encourages this method because it provides information useful in estimating future cash flows that the indirect method does not.
Indirect method
Starts with profit or loss and adjusts for the effects of non-cash items (depreciation, amortisation, provisions, unrealised foreign exchange gains/losses), deferrals or accruals of past or future operating cash receipts/payments, and items of income or expense associated with investing or financing cash flows (gains/losses on disposal of PP&E, interest expense).
Both methods are permitted, and in practice the indirect method is used almost universally, since it can be prepared directly from the balance sheet and profit and loss account without needing a separate cash-basis analysis of receipts and payments.
5. Interest, Dividends and Taxes
IND AS 7 gives entities a choice, applied consistently period to period:
- Interest and dividends paid — classified as operating or financing
- Interest and dividends received — classified as operating or investing
A common approach for a non-financial entity is interest and dividends paid under financing (since they're a cost of obtaining finance) and interest and dividends received under investing (since they're a return on investments) — but classifying them all as operating is equally valid, and is common for financial institutions where interest is central to operating activity. Cash flows from income taxes are generally classified as operating, unless specifically identifiable with financing or investing activities.
6. Non-Cash Transactions
Investing and financing transactions that don't involve cash or cash equivalents are excluded from the cash flow statement entirely. Acquiring an asset through a finance/right-of-use lease, converting debt into equity, or acquiring a business entirely through a share-for-share exchange never appear as cash flows — but they must still be disclosed elsewhere in the financial statements, since omitting them entirely would understate the scale of the entity's investing and financing activity.
7. Reconciling Changes in Liabilities from Financing Activities
IND AS 7 requires a reconciliation between the opening and closing balances of liabilities arising from financing activities — borrowings and lease liabilities — showing changes from both cash flows (drawdowns, repayments) and non-cash changes (new leases entered into, foreign exchange movements, fair value changes, accrued but unpaid interest). This lets users tie the cash flow statement's financing section back to the balance sheet's movement in borrowings, even where part of that movement never touched cash.
8. Worked Example — Indirect Method Cash Flow Statement
Scenario: Kavali Textiles Ltd reports profit before tax of ₹50,00,000 for the year, after charging depreciation of ₹12,00,000 and interest expense of ₹4,00,000. Trade receivables increased by ₹6,00,000, inventory decreased by ₹3,00,000, and trade payables increased by ₹5,00,000. During the year the company bought machinery for ₹20,00,000, raised a term loan of ₹15,00,000, repaid ₹5,00,000 of an existing loan, and paid ₹8,00,000 of dividends. Interest paid and dividends paid are both classified as financing activities; income tax paid was ₹10,00,000.
| Cash Flow Statement (Indirect Method) | Amount (₹) |
|---|---|
| Operating activities | |
| Profit before tax | 50,00,000 |
| Add: Depreciation (non-cash) | 12,00,000 |
| Add: Interest expense (financing item, added back) | 4,00,000 |
| Operating profit before working capital changes | 66,00,000 |
| Less: Increase in trade receivables | (6,00,000) |
| Add: Decrease in inventory | 3,00,000 |
| Add: Increase in trade payables | 5,00,000 |
| Cash generated from operations | 68,00,000 |
| Less: Income tax paid | (10,00,000) |
| Net cash from operating activities | 58,00,000 |
| Investing activities | |
| Purchase of machinery | (20,00,000) |
| Net cash used in investing activities | (20,00,000) |
| Financing activities | |
| Proceeds from term loan | 15,00,000 |
| Repayment of loan | (5,00,000) |
| Interest paid | (4,00,000) |
| Dividends paid | (8,00,000) |
| Net cash used in financing activities | (2,00,000) |
| Net increase in cash and cash equivalents | 36,00,000 |
Note how interest expense of ₹4,00,000 is added back in the operating section (because it was deducted in arriving at profit before tax) and then shown again as an actual cash outflow of ₹4,00,000 in the financing section — this is the standard indirect-method mechanic for any item that affects profit but is reclassified to a different cash flow category.
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| Aspect | Old IGAAP (AS 3) | IND AS 7 |
|---|---|---|
| Core classification and methods | Same three-way classification; direct and indirect methods both permitted | Unchanged — broadly converged with AS 3 |
| Financing-liabilities reconciliation | Not required | Required — opening-to-closing reconciliation of borrowings/lease liabilities showing both cash and non-cash changes (added to IAS 7 in 2016 and carried into IND AS 7) |
| Lease payments | Operating lease rentals were an operating cash outflow; finance lease principal was financing | Under IND AS 116, almost all lease payments' principal portion is a financing cash outflow, since almost all leases are now on-balance-sheet |
| Bank overdraft treatment | Similar treatment where overdraft is integral to cash management | Same principle, unchanged |
| Non-cash transaction disclosure | Required, less prescriptive | Required, with the financing-reconciliation disclosure adding more structure around non-cash financing changes specifically |
10. Other Disclosures
An entity discloses the components of cash and cash equivalents and reconciles the amounts in its cash flow statement to the equivalent items reported in the balance sheet. Where material cash and cash equivalent balances are not available for use by the group (e.g. held in a jurisdiction with exchange controls), that fact and amount must be disclosed together with a commentary. Additional voluntary disclosures — such as the amount of undrawn borrowing facilities available for future operating activities — are encouraged as relevant to understanding the entity's financial position and liquidity.
11. Common Mistakes CAs Make
Error 1 — Classifying the principal portion of lease payments as an operating outflow. Under IND AS 116, the principal repayment of a recognised lease liability is a financing cash outflow — only short-term/low-value lease payments and variable payments excluded from the liability remain operating.
Error 2 — Forgetting to add back interest expense before reclassifying it to financing. Since interest expense already reduced profit before tax, it must be added back in the operating reconciliation before appearing again as an actual cash outflow wherever the entity has chosen to classify interest paid.
Error 3 — Treating a three-month term deposit made mid-year, maturing beyond three months from acquisition, as a cash equivalent. The three-month test is measured from the date of acquisition, not from the reporting date — an instrument with an original maturity beyond three months doesn't become a cash equivalent just because less than three months remain at year-end.
Error 4 — Reporting gross proceeds and repayments of borrowings on a net basis. Major classes of gross cash receipts and payments for financing (and investing) activities are generally reported gross — netting them together obscures the actual scale of financing activity during the period.
Error 5 — Omitting the financing-liabilities reconciliation. This disclosure — showing how borrowings and lease liabilities moved from opening to closing balance, split between cash flows and non-cash changes — is a distinct, separate requirement from the cash flow statement itself, and is frequently missed entirely in smaller companies' first-time IND AS financial statements.
12. FAQs
What are the three categories of cash flows under IND AS 7?
Operating activities — the principal revenue-producing activities, generally derived from the transactions entering into the determination of profit or loss; investing activities — acquisition and disposal of long-term assets and other investments not included in cash equivalents; and financing activities — activities that change the size and composition of the entity's equity and borrowings.
What is the difference between the direct method and the indirect method?
The direct method discloses major classes of gross cash receipts and gross cash payments from operating activities directly (cash received from customers, cash paid to suppliers and employees, and so on). The indirect method starts with profit or loss and adjusts it for the effects of non-cash items (depreciation, provisions), deferrals or accruals, and items classified as investing or financing cash flows. IND AS 7 encourages the direct method but permits either; in practice, the indirect method is used almost universally because it's simpler to prepare directly from the accrual-based financial statements.
What qualifies as a cash equivalent under IND AS 7?
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. An investment normally qualifies only when it has a short maturity of, say, three months or less from the date of acquisition — equity investments are generally excluded unless they are, in substance, a cash equivalent (such as preference shares acquired shortly before their specified redemption date).
How is interest and dividend classified in the cash flow statement?
IND AS 7 permits interest and dividends paid to be classified as either operating or financing activities, and interest and dividends received as either operating or investing activities, as long as the entity applies its choice consistently from period to period. A common approach for a non-financial company is interest paid and dividends paid under financing, and interest received and dividends received under investing — but operating classification is equally acceptable if applied consistently.
Are non-cash transactions included in the statement of cash flows?
No. Investing and financing transactions that do not require the use of cash or cash equivalents — such as acquiring an asset through a finance lease, converting debt to equity, or acquiring a business by issuing shares — are excluded from the statement of cash flows entirely, but must be disclosed elsewhere in the financial statements so users can understand these transactions.
Is IND AS 7 the same as IAS 7?
IND AS 7 is India's converged version of IAS 7 and follows the same three-way classification, direct/indirect method choice, and cash equivalents definition. A notable feature carried into IND AS 7 (added to IAS 7 in 2016) is the requirement to provide a reconciliation of the changes in liabilities arising from financing activities, including both cash and non-cash changes — a disclosure not present in the older Indian AS 3.