Full explanation
Overview
Two companies report the exact same profit. One is generating real cash. The other is a house of cards kept alive by borrowing. The income statement can't tell them apart — the cash flow statement can.
IAS seven is the statement of cash flows. Profit is an opinion — it depends on judgement, estimates, accruals. Cash is a fact. This standard is how a company proves that its profit is actually real money, not just an accounting story.
Cash equivalents
Cash and cash equivalents: short-term, highly liquid, insignificant risk of value change — typically three months or less to maturity from the date acquired. Bank overdrafts repayable on demand are often included as a negative component, part of the entity's cash management, not a financing activity.
Sort everything
Every cash flow sorts into one of three activities: operating — the day-to-day trading; investing — acquiring or disposing of long-term assets; financing — changes in the size and make-up of equity and borrowings.
For operating activities, IAS seven actually encourages the direct method — showing real cash receipts and payments. Almost nobody uses it. Nearly every real filing uses the indirect method instead, starting from profit and working backwards to cash.
Interest & dividends
Interest and dividends paid or received can each be classified as operating OR as investing and financing, depending on the entity and its consistently applied policy. That flexibility is a real source of non-comparability between companies — always check the policy note before comparing operating cash flow across two filings.
Never in the statement
Non-cash transactions never appear IN the cash flow statement itself — an asset acquired through a finance lease, a debt-for-equity swap, a share-for-share acquisition. They're disclosed separately, precisely because no cash moved.
Let's build Meridian's actual cash flow statement, indirect method, start to finish — and watch where a very common mistake creeps in.
Start from profit
Start with profit: eight hundred thousand euros. Add back depreciation of two hundred thousand — it's an expense, but it never used any cash. Now the trap: Meridian sold equipment for one hundred eighty thousand euros cash, recording a thirty thousand euro gain against its one hundred fifty thousand carrying amount.
Gain vs cash
That thirty thousand euro gain sits inside profit, but the cash from the sale belongs entirely under investing. Get this backwards and the gain double-counts. The fix: DEDUCT the thirty thousand euro gain from the operating reconciliation, and show the full one hundred eighty thousand euros of proceeds once, under investing.
Cash from ops
Working capital moves next: receivables increased eighty thousand euros — a use of cash, subtract it. Payables increased fifty thousand — a source of cash, add it. Cash generated from operations: nine hundred forty thousand euros.
From there, deduct interest paid of forty thousand euros and tax paid of one hundred fifty thousand. Net cash from operating activities: seven hundred fifty thousand euros — a real, cash-verified number, not just profit with a different label.
The full picture
Investing activities: five hundred thousand euros spent on new equipment, plus the one hundred eighty thousand euros of disposal proceeds from earlier. Net cash used in investing: three hundred twenty thousand euros.
Tied out
Financing activities: three hundred thousand euros drawn on new borrowings, two hundred thousand euros paid out in dividends. Net cash from financing: one hundred thousand euros. Add it all up against an opening cash balance of one hundred twenty thousand, and Meridian closes the year at six hundred fifty thousand euros.
A real, already-effective amendment worth knowing: the twenty twenty-three Supplier Finance Arrangements rules. Reverse factoring lets a company extend its payment terms through a bank — and it can quietly hide real leverage inside ordinary trade payables.
Hidden leverage
Now companies must disclose the terms of any supplier finance arrangement, the carrying amount of the liabilities involved and where they sit on the balance sheet, how much suppliers have already been paid by the finance provider, the payment-date range versus ordinary payables, and any non-cash changes in those balances.
Flexibility narrows
IFRS eighteen implications: from twenty twenty-seven, the free choice on classifying interest and dividends narrows for most entities — cash flow classification has to follow whichever category, operating, investing or financing, that item sits in under IFRS eighteen's income statement structure. Comparability goes up; the old flexibility goes down.
Still evolving
Also real and dated: the 2026 annual improvements replaced the old 'cost method' reference in paragraph thirty-seven with 'at cost' — a small terminology cleanup. And the IASB is actively working on bigger changes still: transparency of company-defined cash flow measures, consistent classification, and a tighter definition of cash equivalents. Live, unfinished work, not yet law.
Why add back?
Question: why does depreciation get added back if it's an expense? Because it never used any cash. The indirect method starts from profit and strips out every non-cash item to get back to the real cash number.
Interest as investing?
Question: can interest paid ever be an investing or financing cash flow instead of operating? Yes, under the pre-IFRS-eighteen policy choice — but that flexibility narrows sharply once IFRS eighteen applies.
Next up: IFRS seventeen, insurance contracts — how an insurer accounts for a premium collected today against a promise that might not pay out for thirty years. Lenders and credit analysts read the cash flow statement before the income statement, and now you know exactly why that trust is earned.