A cash flow statement shows how the cash and cash equivalents of a business changed over a period, split into three headings: operating, investing and financing activities. Most UK companies that prepare one do so under Section 7 of FRS 102, and almost all of them use the indirect method, which starts from profit and works back to cash. Many smaller companies do not have to prepare one at all: a small entity is exempt, and for financial years beginning on or after 6 April 2025 "small" means meeting two of turnover up to £15 million, balance sheet total up to £7.5 million and no more than 50 employees.
What a cash flow statement shows
The profit and loss account is built on accruals: sales are recognised when earned, costs when incurred, and assets are spread over their lives through depreciation. That is the right way to measure performance, but it says little about whether the business can pay its bills. The cash flow statement fills the gap by reconciling the opening and closing cash position, so a reader can see whether profit turned into cash or got stuck in stock, debtors or new equipment.
FRS 102 paragraph 7.3 requires cash flows to be classified into three groups:
- Operating activities. The principal revenue-producing activities: receipts from customers, payments to suppliers and employees, and normally tax paid;
- Investing activities. Buying and selling long-term assets and investments, such as plant, property, intangibles, shares in other entities and loans made to others;
- Financing activities. Changes in equity and borrowings: share issues, buy-backs, new loans, loan repayments and the principal element of lease payments.
"Cash equivalents" are short-term, highly liquid investments with an insignificant risk of changes in value. Paragraph 7.2 says an investment normally qualifies only when it has a short maturity of, say, three months or less from acquisition. Bank overdrafts are normally a financing item, but where they are repayable on demand and form an integral part of cash management they are treated as part of cash.
The indirect method
Under the indirect method (paragraphs 7.7(a) and 7.8), the statement takes a measure of profit or loss from the income statement and adjusts it for three things:
- Working capital movements. Changes in inventories, operating receivables and operating payables during the period;
- Non-cash items. Depreciation, provisions, deferred tax, accruals, unrealised foreign exchange gains and losses, and similar entries that moved profit without moving cash;
- Investing and financing items. Anything whose cash effect belongs in the other two headings, such as a profit on selling a fixed asset or interest classified as financing.
An illustration, with invented figures: a company reports operating profit of £200,000 after charging £40,000 of depreciation. Over the year trade debtors rose by £30,000, stock fell by £10,000 and trade creditors rose by £15,000. It paid £35,000 of corporation tax.
| Illustrative reconciliation | £ |
|---|---|
| Operating profit | 200,000 |
| Add back depreciation | 40,000 |
| Increase in trade debtors | (30,000) |
| Decrease in stock | 10,000 |
| Increase in trade creditors | 15,000 |
| Cash generated from operations | 235,000 |
| Corporation tax paid | (35,000) |
| Net cash from operating activities | 200,000 |
The logic of the signs is the part people get wrong. An increase in debtors is a deduction because the sales are in profit but the cash has not arrived. An increase in creditors is an addition because the costs are in profit but the cash has not yet gone out. Depreciation is added back because it was a charge with no payment attached.
The direct method
The direct method (paragraph 7.9) presents the major classes of gross cash receipts and payments instead: cash from customers, cash paid to suppliers, cash paid to and on behalf of employees, and so on. It is easier for a non-accountant to read, and the information can come straight from the accounting records or be derived by adjusting sales and cost of sales for working capital movements. FRS 102 permits either method. In practice the indirect method dominates in UK statutory accounts because it falls out of the trial balance and the balance sheet movements with little extra work.
Classification points that cause errors
- Interest and dividends. Paragraphs 7.14 to 7.16 require them to be shown separately and classified consistently from year to year. Interest paid and interest and dividends received may be operating, or financing and investing respectively; dividends paid may be financing or operating;
- Tax. Income tax cash flows are operating unless they can be specifically identified with investing or financing activities (paragraph 7.17);
- Leases. Under the revised FRS 102, a lessee's payments of the principal portion of a lease liability are financing (paragraph 7.6(e)), interest on the lease liability is treated as interest paid, and payments for short-term leases, low-value leases and variable payments outside the liability are operating (paragraph 7.4(h));
- Non-cash transactions. Acquiring an asset by taking on a lease or related liability, buying a business for shares, or converting debt to equity are excluded from the statement and disclosed elsewhere (paragraphs 7.18 and 7.19);
- Disposals. The profit on selling plant sits in profit or loss, but the proceeds are an investing inflow, so the profit is deducted in the operating reconciliation.
Alongside the statement, paragraph 7.22 requires an analysis of changes in net debt, showing cash flows, acquisitions and disposals of subsidiaries, new leases, other non-cash changes and market value and exchange movements. That analysis need not be presented for prior periods. Paragraphs 7.20B and 7.20C add disclosures about supplier finance arrangements for periods beginning on or after 1 January 2025.
Who has to prepare one
The requirement depends on the framework and the size of the entity:
- Small entities. Paragraph 7.1B says a small entity "is not required to comply with this section", and paragraph 3.1B extends this to small entities whatever regime they report under, unless a SORP, law or other regulation requires a statement of cash flows. Small companies reporting under Section 1A of FRS 102 therefore usually do not include one;
- Qualifying entities. A subsidiary included in publicly available consolidated accounts that give a true and fair view can use the reduced disclosure framework and omit the statement under paragraph 1.12(b), subject to the conditions in paragraph 1.11;
- Scope exclusions. Mutual life assurance companies, retirement benefit plans and investment funds meeting all the conditions in paragraph 7.1A are outside Section 7;
- Everyone else. Medium-sized and large entities preparing full FRS 102 accounts, unless they fall within one of the exemptions above, must present one.
Because the small company limits rose for periods beginning on or after 6 April 2025, some companies now qualify for the exemption for the first time. The size tests are covered in our comparison of FRS 101, FRS 102 and FRS 105. Note that dropping the statement from the statutory accounts does not mean losing the information. Lenders and boards often still want it, and our guide to cash flow monitoring covers the internal side.
Under IFRS: IAS 7
Companies reporting under IFRS apply IAS 7, which uses the same three classifications and the same choice of direct or indirect method. That is changing. The amendments that came with IFRS 18 require the indirect method to start from the new operating profit or loss subtotal and introduce new rules for classifying interest and dividend cash flows. IFRS 18 applies to annual reporting periods beginning on or after 1 January 2027, with earlier application permitted.
Acumon prepares full FRS 102 and IFRS financial statements, including the cash flow statement, net debt analysis and the working papers behind them. If you are unsure whether your company still needs one after the threshold changes, our statutory accounts and financial reporting teams can confirm the position and prepare the statement where it is required.