Cash Flow Statement Concept Card Template (Direct, Indirect, FCF)

Cash Flow Statement Concept Card: [Your course or company]

A concept card for the statement of cash flows: the direct and the indirect method, the reconciliation from profit to operating cash flow, the classification of interest, dividends and lease payments under IAS 7 (before and after the IFRS 18 amendments that apply to annual periods beginning on or after 1 January 2027) and under US GAAP ASC 230 and ASC 842, and the free cash flow definitions that analysts, lenders and valuation models use. It is for MBA students in financial accounting and corporate finance, candidates preparing for banking and consulting interviews, and managers who must explain why profit and cash differ. Source basis: IAS 7, IFRS 18, IFRS 16, FASB ASC 230 and 842, and Richards and Laughlin (1980), written up in original words with fictional companies. Replace every [bracketed] value and every row marked Example. This is a learning aid, not accounting, investment or credit advice.

Document control

Contents

1. When to use it
2. The idea in plain language
3. Formulas and notation
4. Classification under IFRS and US GAAP
5. Assumptions and limits
6. How managers use it
7. Worked example A (fully solved)
8. Free cash flow definitions
9. Worked example B (half solved)
10. Exercise C (unsolved)
11. Connections to other cards
12. Common mistakes and misconceptions
13. Self-test questions
14. My notes and next steps
15. Sources and further reading
16. Answer key

When to use it

Use this card when you need to:

• Explain the gap between profit and cash, for example why Northfield earned 19.5 in FY2026 while its cash fell by 28.5.
• Judge liquidity and funding needs: whether operations fund investment and dividends, or whether the company relies on borrowing, equity raises or asset sales (finance/13-week-cash-flow-forecast for the short term).
• Value a business: discounted cash flow models run on free cash flow, not profit (mba/mba-dcf-valuation-card).
• Compare companies that use different standards or policies for interest, dividends and leases.
• Prepare for IFRS 18: from annual periods beginning on or after 1 January 2027, IAS 7 as amended starts the indirect method from operating profit and removes most classification choices for interest and dividends.

The idea in plain language

The cash flow statement lists every movement in cash and cash equivalents during the period in three groups:

• Operating activities: cash from the main revenue-producing activities: customers paying, suppliers and employees being paid, taxes.
• Investing activities: cash spent on, or received from, long-term assets and investments: stores, equipment, software, stakes in other companies, and (under the amended IAS 7) interest and dividends received for most companies.
• Financing activities: cash from and to lenders and owners: borrowing and repaying, lease principal, dividends and (under the amended IAS 7) interest paid for most companies.

There are two ways to present operating cash flow, and they always give the same total:

• Direct method: list the gross cash receipts and payments (from customers, to suppliers, to employees). IAS 7 and ASC 230 both encourage it; few companies use it.
• Indirect method: start from a profit figure and adjust it for everything that was not cash (depreciation, impairment, provisions) and for the change in working capital (receivables, inventory, payables, contract liabilities). Under IAS 7 as amended by IFRS 18 the starting point is operating profit; before that, most companies started from profit for the year or profit before tax.

The working capital logic is the part people get wrong: an increase in an operating asset uses cash (more inventory bought than sold), and an increase in an operating liability provides cash (suppliers not yet paid, gift cards sold but not yet redeemed).

Formulas and notation

Indirect method (IAS 7 as amended by IFRS 18):

$CFO = OP + D\&A + Imp + \Delta Prov - \Delta AR - \Delta Inv - \Delta Prep + \Delta AP + \Delta Accr + \Delta CL - Tax_{paid}$

Direct method, with each line derived from the income statement and the balance sheet:

$Receipts = S - \Delta AR + \Delta CL, \qquad Pay_{sup} = COGS + \Delta Inv - \Delta AP$

$Pay_{emp} = Emp + Sev_{paid}, \qquad Pay_{oth} = Oth + \Delta Prep - \Delta Accr, \qquad Tax_{paid} = Tax + TP_{t-1} - TP_t$

Cash articulation:

$Cash_t = Cash_{t-1} + CFO + CFI + CFF$

Free cash flow to the firm (unlevered), with leases treated as debt: lease payments stay out of the cash flow, so new right-of-use assets acquired through leases count as investment, just like capex:

$FCFF = OP\,(1 - t) + D\&A + Imp + \Delta Prov - \Delta NWC - Capex - NewROU$

Free cash flow to equity, from reported cash flows with interest inside CFO:

$FCFE = CFO - Capex - LeasePrincipal + NetBorrowing$

Classification under IFRS and US GAAP

Companies with a specified main business activity (such as banks, insurers and some investment entities) follow different rules for interest and dividends under the amended IAS 7. As of October 2026, IFRS 18 and its amendments to IAS 7 apply for annual reporting periods beginning on or after 1 January 2027, with earlier application permitted and comparatives restated; check the standard on ifrs.org and any local endorsement before you rely on it.

Assumptions and limits

• Classification affects the subtotals, not the total. Moving interest from operating to financing raises CFO and lowers CFF by the same amount. Compare CFO across companies only on the same basis.
• Leases distort comparisons. Under IFRS 16 the principal part of every lease payment is a financing outflow, so CFO is much higher for a retailer with leased stores than under ASC 842 operating lease accounting, where the whole payment is operating.
• Non-cash transactions are invisible in the totals: new leases, assets bought with shares or with seller finance. IAS 7 and ASC 230 require them to be disclosed separately.
• Timing can be managed. Delaying supplier payments, collecting early or using supplier finance arrangements improve CFO at the reporting date without changing the business. IAS 7 and IFRS 7 require disclosure of supplier finance arrangements (amendments effective for annual periods beginning on or after 1 January 2024).
• Free cash flow has no standard definition. Every analyst, lender and company defines it; always write the formula next to the number.
• The example is simplified. Interest paid equals interest expense, tax is paid with a one-year lag, and there are no foreign exchange effects on cash.

How managers use it

• Treasury and the board fund the plan: dividends, capital spending and debt repayment must be covered by free cash flow or by new financing. A 13-week cash forecast (finance/13-week-cash-flow-forecast) runs the direct method forward.
• Operations own working capital: inventory, supplier terms and collection. At Northfield the FY2026 inventory build of 20.0 consumed more cash than the whole year's profit.
• Investors and lenders test cash conversion (CFO or free cash flow relative to profit or EBITDA) and the sustainability of dividends.
• Valuation and capital budgeting use free cash flow, not profit (mba/mba-npv-irr-card, mba/mba-dcf-valuation-card).

Worked example A (fully solved)

Exhibit A1. Northfield Outdoor Co. inputs (USD m, fictional). Income statement and balance sheet as in mba/mba-three-statements-card.

Balance sheet movements in FY2026: receivables 15.0 to 17.6, inventories 101.0 to 121.0, prepayments 6.4 to 7.0, trade payables 55.0 to 56.5, accrued liabilities 19.2 to 20.0, contract liabilities 10.1 to 11.0, income tax payable 4.6 to 3.9, restructuring provision 0.0 to 1.2.

Step 1. Indirect method from operating profit (IAS 7 as amended by IFRS 18), FY2026.

Step 2. Direct method, FY2026. Same answer from gross flows.

A company that presents expenses by function (cost of sales, selling, administrative) must, under IFRS 18, disclose employee benefits, depreciation, amortisation and impairment by nature in a note; that note is what makes the direct method computable from outside.

Step 3. The same year under Northfield's IAS 7 policy before the amendment. Northfield started the indirect method from profit for the year and classified interest paid and received in operating activities and dividends received in investing activities.

Step 4. Reconciliation of the two bases. 56.3 + 14.9 interest paid moved to financing - 0.8 interest received moved to investing = 70.4. The total change in cash (-28.5) is identical; only the subtotals move. Excel check: =56.3+14.9-0.8-CF!D16 returns 0.

Step 5. A US GAAP reader's view. If Northfield's store leases were operating leases under ASC 842, the whole lease payment (28.0 + 9.3 = 37.3) would be an operating outflow and interest on the loan would also stay in operating: CFO = 70.4 + 0.8 - 5.6 - 37.3 = 28.3. Assuming the straight-line lease cost equals the cash paid, operating profit would be 37.4 + 30.0 - 37.3 = 30.1 and EBITDA 58.4 instead of 95.7. One business, one year: operating cash flow of 70.4, 56.3 or 28.3 depending on the rulebook.

Step 6. From operating profit to operating cash, FY2026.

Conclusion. Operating cash flow fell from 81.4 to 70.4 (IFRS 18 basis) because of working capital (-1.1 in FY2025, -20.0 in FY2026): the 18.9 swing more than explains the 11.0 fall, and the inventory build alone accounts for 20.0. Profit was flat; cash was not.

Free cash flow definitions

Excel (FY2026): FCF-3 =(CF!D16+CF!D19+CF!D23+CF!D24)+CF!D17+CF!D18+CF!D22 gives -8.7 (CFO on the IFRS 18 basis plus interest received less interest paid, then capex and lease principal). FCFF =ROUND(IS!D11*(1-0.25),1)+IS!D20+3.0+CF!D8+SUM(CF!D9:CF!D14)+CF!D17+CF!D18 gives 30.6; subtract the 44.0 of new right-of-use assets (-44.0, from the non-cash transactions note) for -13.4. NOPAT is 37.4 x 0.75 = 28.05, rounded to 28.1. The FY2026 figure is negative because Northfield added an unusually large 44.0 of new store leases while depreciating 30.0 of right-of-use assets.

Check on FCFE: -18.7 + 1.2 dividends from the associate - 11.0 dividends paid = -28.5, the change in cash. In FY2026 Northfield paid a dividend of 11.0 out of negative free cash flow to equity: the dividend and the loan prepayment were funded from the cash balance.

Worked example B (half solved)

Northfield FY2025: operating profit 37.9; D&A 50.0; no impairment or provision; receivables 14.0 to 15.0; inventories 96.0 to 101.0; prepayments 6.0 to 6.4; trade payables 52.0 to 55.0; accrued liabilities 18.0 to 19.2; contract liabilities 9.0 to 10.1; tax expense 6.0; tax payable 4.0 to 4.6; revenue 468.0; cost of sales 262.1; employee benefits 76.0; other cash operating expenses 42.0.

Then: (a) restate CFO under Northfield's old policy (interest paid 14.6 and interest received 0.7 in operating); (b) compute FCF-3 with capex 28.0 and lease principal 25.0.

Exercise C (unsolved)

Corvane Robotics (fictional, growth stage, no specified main business activity, IFRS 18 basis), FY2026, USD m:

Tasks:

1. Prepare the cash flow statement (indirect method from operating loss) and the closing cash balance.
2. Compute FCF-1 (CFO less PP&E and capitalised development) and FCF-3 (also less lease principal).
3. Define the annual cash burn as FCF-3 plus interest received less interest paid. How many months of runway does the closing cash give at that burn?
4. Why does capitalising development costs improve CFO but not free cash flow? What should an analyst do when comparing Corvane with a US GAAP peer that expenses most development under ASC 730?

Connections to other cards

Common mistakes and misconceptions

• Wrong sign on working capital. An increase in receivables or inventory is a use of cash (negative); an increase in payables or contract liabilities is a source (positive).
• Adding back depreciation "because it generates cash". Depreciation generates nothing; it is added back because it reduced profit without using cash in the period. The cash left when the asset was bought.
• Starting the amended IAS 7 indirect method from profit for the year. From 2027 the starting point is operating profit, so interest, the associate share and tax are no longer reconciling items.
• Comparing CFO across IFRS and US GAAP companies. Interest classification and operating leases can move CFO by a third or more (Northfield: 70.4 versus 28.3).
• Calling CFO less capex "free cash flow" for a retailer under IFRS 16. It ignores lease principal, which is a store cost as real as rent. Subtract it, or treat leases consistently as debt everywhere.
• Forgetting non-cash transactions. New leases (44.0) and assets bought with shares do not pass through the cash flow statement; in a three-statement model do not book them as cash capex and also as new lease liabilities. In a valuation that counts leases as debt they are a non-cash investment deducted from FCFF (see the FCFF table).
• Mixing FCFF with the wrong discount rate or net debt. FCFF goes with WACC and enterprise value; FCFE goes with the cost of equity and equity value. Leases in FCFF and in net debt must be treated the same way.
• Treating a strong CFO as proof of quality. CFO can be raised by stretching payables, supplier finance, factoring receivables or cutting maintenance spending. Read the working capital lines and the supplier finance disclosure.
• Ignoring restricted cash and overdrafts. Check what the company includes in cash and cash equivalents.

Self-test questions

1. Name the three sections of the cash flow statement and put each of these in one section under IAS 7 as amended by IFRS 18: lease principal, interest received, purchase of software, dividends paid, income taxes paid.
2. What is the starting point of the indirect method under the amended IAS 7, and under US GAAP?
3. Northfield's inventory rose by 20.0. What is the effect on the indirect method, and why?
4. Why do the direct and indirect methods always give the same CFO?
5. Reconcile Northfield's FY2026 CFO of 56.3 (old policy) to 70.4 (amended IAS 7).
6. Why is CFO for an IFRS 16 retailer higher than for an otherwise identical US GAAP retailer with operating leases?
7. Gift card sales exceed redemptions by 0.9. Which method shows this directly, and where?
8. Define FCFF and FCFE and name the discount rate that goes with each.
9. Northfield paid dividends of 11.0 in FY2026. Were they covered by free cash flow to equity? Show the numbers.
10. A company's CFO jumps because it moved to 120-day supplier terms through a bank's supplier finance programme. Where would you find this, and how would you adjust?
11. True or false: the IFRS 18 amendments change Northfield's net change in cash for FY2026.

My notes and next steps

Sources and further reading

• IFRS Foundation. IAS 7 Statement of Cash Flows, including the amendments made by IFRS 18 Presentation and Disclosure in Financial Statements (annual periods beginning on or after 1 January 2027) and the 2023 supplier finance arrangements amendments. https://www.ifrs.org (checked 2026-10-28).
• IFRS Foundation. IFRS 16 Leases (effective 1 January 2019); IAS 38 Intangible Assets. https://www.ifrs.org.
• FASB. ASC 230 Statement of Cash Flows; ASU 2016-02 Leases (Topic 842); ASC 730 Research and Development. https://www.fasb.org (checked 2026-10-28).
• Richards, V. D., and Laughlin, E. J. (1980). A cash conversion cycle approach to liquidity analysis. Financial Management, 9(1), 32-38.
• Sloan, R. G. (1996). Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review, 71(3), 289-315.
• Textbooks (further reading by name only): Penman, S. H., Financial Statement Analysis and Security Valuation (McGraw Hill); Koller, T., Goedhart, M. and Wessels, D., Valuation: Measuring and Managing the Value of Companies (Wiley); Berk, J. and DeMarzo, P., Corporate Finance (Pearson).
• Open resource: OpenStax, Principles of Accounting, Volume 1: Financial Accounting (CC BY-NC-SA 4.0), chapter on the statement of cash flows, openstax.org.

Answer key

Worked example B. Indirect: 37.9 + 50.0 - 1.0 - 5.0 - 0.4 + 3.0 + 1.2 + 1.1 - 5.4 = 81.4 (inventories -5.0, trade payables +3.0, contract liabilities +1.1, taxes paid 6.0 + 4.0 - 4.6 = 5.4). Direct: receipts 468.0 - 1.0 + 1.1 = 468.1; suppliers 262.1 + 5.0 - 3.0 = 264.1; employees 76.0; other 42.0 + 0.4 - 1.2 = 41.2; taxes 5.4; CFO = 468.1 - 264.1 - 76.0 - 41.2 - 5.4 = 81.4. (a) Old policy: 81.4 + 0.7 - 14.6 = 67.5. (b) FCF-3 = 67.5 - 28.0 - 25.0 = 14.5.

Exercise C. (1) CFO = -6.0 + 5.0 + 3.2 - 6.0 - 5.0 + 2.4 + 2.5 - 0.2 = -4.1. CFI = -7.5 - 3.0 + 1.1 = -9.4. CFF = 40.0 - 0.6 - 0.3 - 1.8 = 37.3. Net change = 23.8; closing cash = 6.2 + 23.8 = 30.0. (2) FCF-1 = -4.1 - 7.5 - 3.0 = -14.6; FCF-3 = -14.6 - 1.8 = -16.4. (3) Burn = -16.4 + 1.1 - 0.9 = -16.2 a year, or 1.35 a month; runway = 30.0 / 1.35 = about 22.2 months. (4) Capitalised development is an investing outflow, so CFO looks better than at a company that expenses it; free cash flow subtracts it either way. To compare with a US GAAP peer that expenses most development, subtract Corvane's capitalised development from its CFO (or compare free cash flow rather than CFO).

Self-test.

1. Operating, investing, financing. Lease principal: financing. Interest received: investing. Software: investing. Dividends paid: financing. Income taxes paid: operating.
2. Operating profit or loss (amended IAS 7); net income (US GAAP).
3. A deduction of 20.0: cash was spent on stock that has not yet been sold, so cost of sales (and profit) does not include it.
4. Both describe the same cash movements; the indirect method reaches them by adjusting accrual profit for non-cash items and working capital, the direct method lists them gross.
5. 56.3 + 14.9 interest paid (now financing) - 0.8 interest received (now investing) = 70.4.
6. Under IFRS 16 the lease principal is financing (and under the amended IAS 7 the interest too); under ASC 842 operating leases the whole payment is operating.
7. The direct method, inside cash received from customers (revenue - increase in receivables + increase in contract liabilities); the indirect method shows it as the increase in contract liabilities.
8. FCFF: cash flow available to all capital providers after operating costs, taxes on operating profit and investment; discount at WACC. FCFE: cash available to shareholders after debt service and net borrowing; discount at the cost of equity.
9. No. FCFE was -18.7; the dividend of 11.0 and the loan prepayment were funded from cash, which fell by 28.5.
10. In the liquidity risk and supplier finance disclosures (IAS 7 and IFRS 7) and in the payables note. Adjust by treating the extended payables as debt-like: reduce CFO by the increase in payables under the programme and add the balance to net debt.
11. False. Only the split between operating, investing and financing changes.

Revision history

Standard and licence note

Based on IAS 7 as issued and as amended by IFRS 18, IFRS 16, and FASB ASC 230 and 842, using standard numbers, concept names and effective dates only, checked on ifrs.org and fasb.org on 2026-10-28, and on the research named above. The explanations, exhibits, free cash flow table and questions are original; Northfield Outdoor Co. and Corvane Robotics are fictional. The template is independent and not affiliated with or endorsed by the IFRS Foundation, the FASB or any business school. Check the current official versions before you rely on any date or requirement. Template licence: MIT.