IAS 7 Statement of Cash Flows

IAS 7 Statement of Cash Flows: The Complete 2026 Guide for Indian Preparers

IAS 7 — mirrored in India by Ind AS 7 for Ind AS companies and AS 3 under the legacy GAAP framework — requires every entity to present a statement of cash flows classified into operating, investing, and financing activities. You may use the direct method or the indirect method for operating activities. Cash equivalents are limited to instruments with an original maturity of three months or less. Since the 2017 amendment, you must also disclose a reconciliation of all liabilities arising from financing activities. Get these classifications and disclosures right, and your financial statements pass the cash-conversion test that lenders and analysts run before they read anything else.

Which Standard Applies to Your Entity in FY 2026-27?

Before opening the spreadsheet, confirm which framework governs your cash flow statement — the consequences of getting this wrong include a qualified audit report and restatement.

Ind AS 7 applies to all companies within the Ind AS applicability threshold: listed companies (any exchange), unlisted companies with a net worth of Rs. 250 crore or more, and subsidiaries or associates of Ind AS companies. Phase I companies adopted Ind AS from FY 2016-17; Phase II from FY 2017-18. If your company prepares financial statements under Schedule III (Division II) of the Companies Act 2013, Ind AS 7 governs your cash flow statement.

AS 3 (ICAI Accounting Standards for non-Ind AS entities) applies to companies still on the legacy framework — typically unlisted companies with net worth below Rs. 250 crore. The substance of AS 3 is very similar to IAS 7, but the 2017 financing-liabilities reconciliation requirement is not explicitly codified in the older AS 3 text.

IAS 7 (full IFRS) applies to Indian entities reporting under IFRS — foreign subsidiaries of Indian groups, overseas listing vehicles, or entities raising capital in IFRS-mandatory jurisdictions.

This article focuses on Ind AS 7 and IAS 7, with AS 3 differences flagged where they are material.

Why the Cash Flow Statement Is the Most Scrutinised Statement in 2026

A profit-and-loss account can be shaped by revenue recognition judgements, depreciation useful-life choices, and provisioning policy. A balance sheet carries goodwill, intangibles, and deferred tax at values that depend on assumptions. Cash is binary: it either arrived in the bank account or it did not.

Three forces are pushing the cash flow statement to the centre of financial analysis in FY 2026-27:

1. Credit committee scrutiny under RBI's IRACP norms. Banks and NBFCs now run operating cash flow cover ratios as a front-end test before sanctioning working capital limits. A statement showing operating cash flow of Rs. 60 lakhs against a reported PAT of Rs. 1.2 crore is the first red flag in a credit committee note.

1. SEBI's disclosure push for listed entities. Continuous disclosure formats for listed companies cross-reference reported EBITDA with operating cash flows. A persistent and unexplained gap is now flagged in analyst calls and ESG-linked lending frameworks.

1. PE and M&A due diligence. Every share purchase agreement negotiation starts with a reconciliation of EBITDA to free cash flow. A carelessly prepared cash flow statement forces the target to re-prepare it during due diligence — a costly, deal-disrupting exercise that erodes valuation credibility.

Getting Ind AS 7 right is not a compliance checkbox. It is a commercial asset.

The Three Activity Categories: What Goes Where

Ind AS 7 divides every cash movement into one of three buckets. Misclassification between them does not change the net change in cash — but it does distort the story, inflating operating cash flow at the expense of financing, or vice versa.

Operating Activities

Operating activities are the principal revenue-producing activities of the business and any other activities not classified as investing or financing:

• Collections from customers (gross, under the direct method; implied, under the indirect method)
• Payments to suppliers and employees
• Income tax paid — classified here by default unless specifically identifiable with an investing or financing transaction
• GST collected and remitted — generally shown on a pass-through (net) basis; your accounting policy note must state this

Investing Activities

Investing activities arise from acquiring and disposing of long-term assets and non-trading investments:

• Cash paid for property, plant and equipment (PPE) and intangible assets
• Capital advances paid to contractors — these are investing outflows, not working capital
• Purchase and redemption of non-current investments (equity, bonds held to maturity)
• Loans extended to and repaid by related parties (unless you are a financial institution)
• Proceeds from disposal of a subsidiary, net of cash transferred

Financing Activities

Financing activities change the size or composition of equity and borrowings:

• Proceeds from issue of equity shares, preference shares, debentures, NCDs
• Repayment of term loans and bonds
• Principal repayment of lease liabilities under Ind AS 116 (this is the single biggest change from AS 3 thinking)
• Dividends paid to equity shareholders and to non-controlling interests
• Share buy-back payments

One trap worth highlighting: the interest component of lease payments (i.e., the unwinding of the lease liability discount under Ind AS 116) is typically classified under financing, not operating, for non-financial entities — unless the entity has adopted the policy of classifying all interest paid under operating.

Direct Method vs Indirect Method: A Practical Comparison

The Direct Method

The direct method presents each major class of gross cash receipt and payment. A simplified presentation:

`` Cash collected from customers Rs. 18,40,00,000 Cash paid to suppliers (Rs. 11,20,00,000) Cash paid to employees (Rs. 3,60,00,000) Income tax paid (Rs. 85,00,000) Net cash from operating activities Rs. 2,75,00,000 ``

IAS 7 encourages the direct method because it gives users unambiguous gross flow information. However, building it requires a full analysis of every bank entry tagged by payment type — work that most mid-size Indian ERP setups do not auto-generate.

The Indirect Method

The indirect method reconciles profit before tax to net cash from operating activities. This is what you see in virtually every Indian Ind AS financial statement:

``` Profit before tax Rs. 1,20,00,000 Add: Depreciation and amortisation Rs. 42,00,000 Add: Finance costs Rs. 18,00,000 Less: Interest income (Rs. 6,00,000) Less: Profit on sale of PPE (Rs. 3,50,000) Operating profit before working capital changes Rs. 1,70,50,000

Increase in trade receivables (Rs. 28,00,000) Decrease in inventories Rs. 11,50,000 Increase in trade payables Rs. 14,00,000 Cash generated from operations Rs. 1,68,00,000 Income tax paid (Rs. 33,00,000) Net cash from operating activities Rs. 1,35,00,000 ```

The critical discipline: every adjustment to profit before tax must have a mirror entry elsewhere in the statement. Finance costs added back in operating must appear as a cash outflow in financing. Interest income added back must appear as a cash receipt in investing. If the mirror is missing, the statement is arithmetically wrong even if the bottom-line net change ties.

Accounting Policy Choices: Interest and Dividends

Ind AS 7 permits a choice on four line items. Once made, the policy must be applied consistently and disclosed in the notes.

Indian practice for non-financial entities: Classify interest paid under financing, interest received under investing, dividends paid under financing, and dividends received under investing. This is consistent with the ICAI Guidance Note on Division II (Schedule III) financial statements and reflects the economic nature of these flows most clearly.

Financial institutions (banks, NBFCs, HFCs) typically classify both interest paid and interest received under operating, because interest is the core revenue and cost of their business.

Cash and Cash Equivalents: Where Indian Preparers Get It Wrong

Ind AS 7 defines cash equivalents as short-term, highly liquid investments that are readily convertible to known amounts of cash and subject to insignificant risk of changes in value. The working benchmark — not a hard statutory rule but universally applied — is an original maturity of three months or less from the date of acquisition.

What qualifies:

• Current account and savings account balances
• Call money deposits (overnight to a few days)
• Treasury bills with original maturity of 91 days or less
• Overnight / liquid category mutual funds with daily redemption and negligible NAV volatility (verify the fund's maturity profile)
• Bank overdraft repayable on demand that forms an integral part of cash management

What does not qualify:

• Fixed deposits with original maturity exceeding three months — even if the remaining maturity at the balance sheet date is less than three months (original maturity controls, not residual maturity)
• Debt mutual funds with lock-in periods or exit loads extending beyond three months
• FMPs, interval funds, and credit-risk category debt funds
• Gold, sovereign gold bonds, digital gold, or commodity ETFs
• Fixed deposits pledged as margin money, lien-marked against LCs, or under a charge — these are restricted cash and must be disclosed separately, not included in cash equivalents

The integral-cash-management test for overdrafts: If your entity operates a cash-pool arrangement where account balances fluctuate between credit and debit within the same bank group and the overdraft is used to fund short-term operating payments, it passes the test. A standalone term overdraft or a separately sanctioned overdraft limit used purely as a borrowing facility does not pass, and should appear in financing inflows/outflows.

Worked Example: Full Statement for Prism Manufacturing Pvt. Ltd., FY 2026-27

All figures in Rs. Lakhs. Prism Manufacturing Pvt. Ltd. is a mid-size auto-components manufacturer applying Ind AS.

Inputs from P&L and balance sheet:

• Profit before tax: Rs. 93 (PAT Rs. 72 + income tax paid Rs. 21)
• Depreciation: Rs. 45; Finance costs: Rs. 22; Interest income from FDs: Rs. 8
• Profit on sale of old machinery: Rs. 5
• Trade receivables up Rs. 38; inventories down Rs. 14; trade payables up Rs. 19; provisions up Rs. 3
• PPE purchased: Rs. 110 total, of which Rs. 20 was against an existing trade payable (non-cash — only Rs. 90 was actual cash outflow)
• FD opened: Rs. 30 (12-month term — not a cash equivalent)
• Machinery sold for Rs. 12; term loan drawn Rs. 80; term loan repaid Rs. 35
• Dividends paid Rs. 15; interest paid Rs. 22; income tax paid Rs. 21

Operating Activities: `` Profit before tax Rs. 93.00 Add: Depreciation Rs. 45.00 Add: Finance costs Rs. 22.00 Less: Interest income (Rs. 8.00) Less: Profit on sale of machinery (Rs. 5.00) Operating profit before WC changes Rs. 147.00 Increase in trade receivables (Rs. 38.00) Decrease in inventories Rs. 14.00 Increase in trade payables Rs. 19.00 Increase in provisions Rs. 3.00 Cash generated from operations Rs. 145.00 Income tax paid (Rs. 21.00) Net cash from operating activities Rs. 124.00 ``

Investing Activities: `` Purchase of PPE (cash only) (Rs. 90.00) Proceeds from sale of machinery Rs. 12.00 FD opened (12-month maturity) (Rs. 30.00) Interest received Rs. 8.00 Net cash used in investing activities (Rs. 100.00) ``

Financing Activities: `` Term loan drawn Rs. 80.00 Term loan repaid (Rs. 35.00) Interest paid (Rs. 22.00) Dividends paid (Rs. 15.00) Net cash from financing activities Rs. 8.00 ``

Net increase in cash and cash equivalents: Rs. 124 − Rs. 100 + Rs. 8 = Rs. 32 lakhs

Mandatory non-cash disclosure (note to financial statements): PPE of Rs. 20 lakhs was acquired during the year against an existing trade payable; this has been excluded from investing cash outflows and is disclosed as a significant non-cash investing and financing transaction per paragraph 43 of Ind AS 7. Omitting this note is a recurring audit finding and a Schedule III compliance gap.

The 2017 Financing Liabilities Reconciliation: Build It Before Your Audit

The 2016 amendment to IAS 7 (effective for annual periods beginning on or after 1 January 2017, adopted in Ind AS 7 simultaneously) added a mandatory disclosure: a reconciliation of the opening and closing carrying amounts of all liabilities arising from financing activities, distinguishing between cash and non-cash changes.

For Prism Manufacturing's term loan in FY 2026-27:

If the entity carries Ind AS 116 lease liabilities, add a separate block showing: opening lease liability, additions from new leases signed during the year, lease modifications, interest accretion (non-cash), principal cash payments, and closing balance. The closing balance of every row must tie to the balance sheet — if it does not, the lender's covenant compliance certificate cannot be signed.

Maintain this reconciliation as a machine-readable working paper. It is the first document requested by banks during annual credit review, by rating agencies during surveillance visits, and by buy-side analysts building leveraged-return models.

Pitfalls to Avoid: Eight Errors That Appear in Practice

1. Gross vs. net error on PPE acquired against payables. Only the cash portion of a PPE purchase belongs in investing outflows. The payable portion is a non-cash transaction disclosed in the notes.

1. Treating all mutual funds as cash equivalents. Overnight and liquid category funds with daily redemption generally qualify. FMPs, interval funds, dynamic bond funds, and equity-linked funds do not — regardless of NAV.

1. Netting GST without a policy note. GST collected from customers and GST paid to the government is a pass-through. Your accounting policy note must explicitly state whether you show GST on a gross or net basis. Inconsistency between years creates analytical noise.

1. Showing full lease rental as operating. Under Ind AS 116, the principal component of a lease liability payment is a financing outflow, and the interest component is a financing outflow (or operating, per policy). Treating the entire cash rent as an operating outflow — the pre-Ind AS 116 habit — is wrong.

1. Parking capital advances in working capital. Capital advances paid to equipment suppliers or construction contractors are investing outflows. They frequently end up misclassified as a movement in "loans and advances" within operating — inflating operating cash flow and understating investing outflows.

1. Omitting the financing liabilities reconciliation. This has been mandatory since 2017. It remains absent from a surprising number of smaller Ind AS financial statements, resulting in modified audit opinions.

1. Including pledged deposits in cash and cash equivalents. A deposit under lien is not freely available and must not be netted into cash equivalents. Disclose the restriction and the amount separately.

1. Inconsistent treatment of advance income tax and refunds. Advance tax outflows and self-assessment tax outflows are operating. Income tax refunds received are operating inflows. Neither should be classified as investing simply because the underlying income included capital gains.

Key Takeaways

• The three-way split is the entire point. Operating, investing, and financing cash flows tell three distinct stories about business quality, capital discipline, and financial risk. A single misclassification corrupts all three ratios that analysts and lenders derive from the statement.
• Cash equivalents are narrower than most preparers assume. Original maturity — not residual maturity at year-end — is the test. Fixed deposits beyond three months, most debt funds, and pledged instruments do not qualify.
• The indirect method demands mirror-entry discipline. Every non-cash item added back to profit (depreciation, finance costs) must reappear as an actual cash outflow somewhere else in the statement. If it does not, the statement is arithmetically defective.
• Non-cash transactions must be disclosed in the notes. PPE acquired against payables, bonus share issues, debt-to-equity conversions, and right-of-use asset additions under Ind AS 116 — none pass through the body of the statement, but all are required disclosures under paragraph 43 of Ind AS 7.
• The financing liabilities reconciliation is mandatory, not optional. Build the working paper table for every borrowing and lease liability line, reconciling opening to closing balance through cash flows and non-cash movements, before your statutory audit begins.
• Ind AS 116 has permanently changed the financing section. Principal lease repayments are financing outflows. Interest on lease liabilities is a financing outflow (for most non-financial entities). If you are still treating the full lease payment as an operating outflow, your statement is misstated.
• A clean, cross-referenced cash flow statement is a commercial asset in FY 2026-27. Credit committees, PE due-diligence teams, and rating agency analysts run their first quality-of-earnings test against operating cash flow. A statement that is clearly prepared, fully reconciled, and consistent with the balance sheet shortens credit timelines, strengthens covenant discussions, and signals management credibility.