# 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.

<!--
Guidance: How to use this template
- Read "The idea in plain language" and the classification table first. Then rebuild Worked example A with the same
  statement layout as mba/mba-three-statements-card (sheets IS, BS and CF; FY2024 in column B, FY2025 in column C,
  FY2026 in column D).
- Build the indirect method first, then the direct method, and check that both give the same operating cash flow.
  Then compute every free cash flow definition and say in one sentence what each one is for.
- Complete Worked example B (FY2025) and Exercise C (Corvane Robotics) before you look at the answer key.
- Northfield Outdoor Co. (outdoor-gear retailer, stores plus online) and Corvane Robotics (growth-stage
  warehouse-robotics company) are fictional. Amounts are USD millions; every number was computed in Python.
- Related templates: mba/mba-financial-accounting-guide, mba/mba-three-statements-card, mba/mba-ratio-analysis-card,
  mba/mba-dcf-valuation-card, mba/mba-npv-irr-card, mba/mba-venture-finance-cap-table-card, mba/mba-formula-sheet,
  finance/13-week-cash-flow-forecast, finance/working-capital-review, finance/lease-accounting-memo,
  finance/ifrs-18-transition-plan, finance/valuation-report, finance/credit-memo.
-->

## Document control

<!-- Guidance: Record which basis your cash flow figures use. The same company can show three different operating cash flows depending on the standard and the policy for interest. -->

| Field | Value |
|---|---|
| Course or purpose | [Financial accounting core / corporate finance / credit or valuation work] |
| Learner or analyst | [Your name] |
| Company | Northfield Outdoor Co. (fictional) / [your company] |
| Cash flow basis | [IAS 7 before the IFRS 18 amendments / IAS 7 as amended by IFRS 18 / US GAAP ASC 230] |
| Policy for interest and dividends | [Interest paid in operating or financing; received in operating or investing] |
| Free cash flow definition used | [FCF after leases / FCFF / FCFE; write the formula] |
| Standards checked on | 2026-10-28 (ifrs.org, fasb.org) |
| Reviewed by | [Study partner, tutor or mentor] |
| Version | [0.1] |
| Last updated | YYYY-MM-DD |

## Contents

1. [When to use it](#when-to-use-it)
2. [The idea in plain language](#the-idea-in-plain-language)
3. [Formulas and notation](#formulas-and-notation)
4. [Classification under IFRS and US GAAP](#classification-under-ifrs-and-us-gaap)
5. [Assumptions and limits](#assumptions-and-limits)
6. [How managers use it](#how-managers-use-it)
7. [Worked example A (fully solved)](#worked-example-a-fully-solved)
8. [Free cash flow definitions](#free-cash-flow-definitions)
9. [Worked example B (half solved)](#worked-example-b-half-solved)
10. [Exercise C (unsolved)](#exercise-c-unsolved)
11. [Connections to other cards](#connections-to-other-cards)
12. [Common mistakes and misconceptions](#common-mistakes-and-misconceptions)
13. [Self-test questions](#self-test-questions)
14. [My notes and next steps](#my-notes-and-next-steps)
15. [Sources and further reading](#sources-and-further-reading)
16. [Answer key](#answer-key)

## When to use it

<!-- Guidance: Reach for the cash flow statement whenever profit and cash tell different stories, and whenever someone quotes "free cash flow" without a definition. -->

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

<!-- Guidance: Be able to answer "walk me through the cash flow statement" in 60 seconds: three sections, the indirect method logic, and the link to the balance sheet. -->

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).

```mermaid
flowchart TD
  A["A cash flow item"] --> B{"Customers, suppliers, employees, taxes or other operating items?"}
  B -->|"yes"| OP["Operating activities"]
  B -->|"no"| C{"Interest or dividends?"}
  C -->|"no"| D{"Buying or selling long-term assets or investments?"}
  D -->|"yes"| INV["Investing activities"]
  D -->|"no"| FIN["Financing activities: borrowing, repaying, lease principal, equity, dividends paid"]
  C -->|"yes"| E{"Which framework?"}
  E -->|"IAS 7 amended by IFRS 18, no specified main business activity"| F["Interest and dividends received: investing. Interest and dividends paid: financing"]
  E -->|"US GAAP ASC 230"| G["Interest paid, interest and dividends received: operating. Dividends paid: financing"]
  E -->|"IAS 7 before the amendment"| H["Policy choice, applied consistently and disclosed"]
```

## Formulas and notation

<!-- Guidance: Use these as spreadsheet checks. The indirect and direct results must match to the decimal. -->

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:

$$FCFE = CFO - Capex - LeasePrincipal + NetBorrowing$$

| Symbol | Meaning | Northfield FY2026 (USD m) |
|---|---|---|
| $OP$ | Operating profit (IFRS 18 subtotal) | 37.4 |
| $D\&A$ | Depreciation of PP&E (19.5) and right-of-use assets (30.0), amortisation of software (5.8) | 55.3 |
| $Imp$ | Impairment of right-of-use assets | 3.0 |
| $\Delta Prov$ | Increase in restructuring provision | 1.2 |
| $\Delta AR$, $\Delta Inv$, $\Delta Prep$ | Increase in receivables, inventories, prepayments | 2.6, 20.0, 0.6 |
| $\Delta AP$, $\Delta Accr$, $\Delta CL$ | Increase in trade payables, accrued liabilities, contract liabilities | 1.5, 0.8, 0.9 |
| $\Delta NWC$ | Net increase in operating working capital (2.6 + 20.0 + 0.6 - 1.5 - 0.8 - 0.9) | 20.0 |
| $Emp$, $Oth$ | Employee benefits expense, other cash operating expenses (by-nature note) | 82.0, 46.5 |
| $Sev_{paid}$ | Severance paid (3.6 expensed, 1.2 still provided) | 2.4 |
| $Tax$, $TP$ | Income tax expense, income tax payable (opening 4.6, closing 3.9) | 5.8 |
| $Capex$ | Purchases of PP&E (30.0) and software (7.0) | 37.0 |
| $NewROU$ | Right-of-use assets added through new leases (non-cash) | 44.0 |
| $t$ | Tax rate | 25% |

## Classification under IFRS and US GAAP

<!-- Guidance: This table is the most examined part of the topic in 2026 and 2027, because IFRS reporters move to the amended IAS 7 at the same time as IFRS 18. Facts checked on 2026-10-28; check ifrs.org and fasb.org before you rely on them. -->

| Item | IAS 7 before the IFRS 18 amendments | IAS 7 as amended by IFRS 18 (company without a specified main business activity) | US GAAP ASC 230 |
|---|---|---|---|
| Starting point of the indirect method | Profit or loss (in practice profit for the year or profit before tax) | Operating profit or loss | Net income |
| Interest paid | Operating or financing (policy choice) | Financing | Operating |
| Interest received | Operating or investing (policy choice) | Investing | Operating |
| Dividends received | Operating or investing (policy choice) | Investing | Operating |
| Dividends paid | Operating or financing (policy choice) | Financing | Financing |
| Lease payments, principal | Financing (IFRS 16) | Financing | Finance leases: financing. Operating leases (ASC 842): operating |
| Lease payments, interest | Per the interest paid policy | Financing | Finance leases: operating. Operating leases: operating (within the single lease payment) |
| Income taxes paid | Operating unless specifically identified with investing or financing | Same | Operating |
| Direct method | Encouraged | Encouraged | Encouraged; a reconciliation of net income to CFO is also required |

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

<!-- Guidance: Know what the cash flow statement cannot tell you, especially when you compare companies. -->

- **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

<!-- Guidance: Name the cash measure your organisation actually manages to: operating cash flow, free cash flow after leases, or cash conversion. -->

- **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)

<!-- Guidance: Build the indirect method first, the direct method second, then the reconciliation between the IAS 7 policy Northfield used before IFRS 18 and the amended IAS 7. Every total must agree with the balance sheet cash line. -->

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

| Item | FY2025 | FY2026 |
|---|---|---|
| Revenue | 468.0 | 512.0 |
| Cost of sales | 262.1 | 284.2 |
| Employee benefits expense (by-nature note) | 76.0 | 82.0 |
| Other cash operating expenses (by-nature note) | 42.0 | 46.5 |
| Depreciation and amortisation | 50.0 | 55.3 |
| Restructuring: impairment 3.0, severance 3.6 (2.4 paid) | 0.0 | 6.6 |
| Operating profit | 37.9 | 37.4 |
| Share of profit of associate / interest income | 1.6 / 0.7 | 2.0 / 0.8 |
| Interest expense: loan / leases | 5.6 / 9.0 | 5.6 / 9.3 |
| Income tax expense | 6.0 | 5.8 |
| Profit for the year | 19.6 | 19.5 |
| Capex: PP&E / software | 22.0 / 6.0 | 30.0 / 7.0 |
| New leases (non-cash) / lease principal paid | 30.0 / 25.0 | 44.0 / 28.0 |
| Dividends received from associate / dividends paid | 1.0 / 10.0 | 1.2 / 11.0 |
| Loan repayment | 0.0 | 10.0 |
| Cash at 31 December (FY2024 45.0) | 50.5 | 22.0 |

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.**

| CF row | Line | FY2026 | Excel |
|---|---|---|---|
| 5 | Operating profit | 37.4 | `=IS!D11` |
| 6 | Depreciation and amortisation | 55.3 | `=IS!D20` |
| 7 | Impairment of right-of-use assets | 3.0 | from the restructuring note |
| 8 | Increase in restructuring provision | 1.2 | `=BS!D19-BS!C19` |
| 9 | Increase in trade receivables | -2.6 | `=-(BS!D6-BS!C6)` |
| 10 | Increase in inventories | -20.0 | `=-(BS!D7-BS!C7)` |
| 11 | Increase in prepayments | -0.6 | `=-(BS!D8-BS!C8)` |
| 12 | Increase in trade payables | 1.5 | `=BS!D15-BS!C15` |
| 13 | Increase in accrued liabilities | 0.8 | `=BS!D16-BS!C16` |
| 14 | Increase in contract liabilities | 0.9 | `=BS!D17-BS!C17` |
| 15 | Income taxes paid | -6.5 | `=-(IS!D18+BS!C18-BS!D18)` |
| 16 | **Net cash from operating activities** | **70.4** | `=SUM(D5:D15)` |
| 17 to 20 | Investing: PP&E -30.0, software -7.0, interest received 0.8, dividends from associate 1.2 | **-35.0** | `=SUM(D17:D20)` |
| 22 to 26 | Financing: lease principal -28.0, lease interest -9.3, loan interest -5.6, loan repayment -10.0, dividends paid -11.0 | **-63.9** | `=SUM(D22:D26)` |
| 28 | **Net change in cash** | **-28.5** | `=D16+D21+D27` |
| 30 | Closing cash (opening 50.5) | 22.0 | `=D28+BS!C5`, equals `BS!D5` |

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

| Line | Derivation | FY2026 | Excel |
|---|---|---|---|
| Cash received from customers | 512.0 - 2.6 + 0.9 | 510.3 | `=IS!D5-(BS!D6-BS!C6)+(BS!D17-BS!C17)` |
| Cash paid to suppliers of merchandise | 284.2 + 20.0 - 1.5 | -302.7 | `=-(IS!D6+(BS!D7-BS!C7)-(BS!D15-BS!C15))` |
| Cash paid to employees | 82.0 + 2.4 severance paid | -84.4 | `=-(82.0+2.4)` |
| Other operating payments | 46.5 + 0.6 - 0.8 | -46.3 | `=-(46.5+(BS!D8-BS!C8)-(BS!D16-BS!C16))` |
| Income taxes paid | 5.8 + 4.6 - 3.9 | -6.5 | `=-(IS!D18+BS!C18-BS!D18)` |
| **Net cash from operating activities** | | **70.4** | sum of the five lines above, equals `CF!D16` |

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.

| Line | FY2026 |
|---|---|
| Profit for the year | 19.5 |
| Add income tax expense | 5.8 |
| Add finance costs | 14.9 |
| Less finance income | -0.8 |
| Less share of profit of associate | -2.0 |
| = Operating profit (implicit) | 37.4 |
| Add D&A 55.3, impairment 3.0, provision 1.2; working capital -20.0 | 39.5 |
| **Cash generated from operations** | **76.9** |
| Interest paid (loan 5.6, leases 9.3) | -14.9 |
| Interest received | 0.8 |
| Income taxes paid | -6.5 |
| **Net cash from operating activities** | **56.3** |
| Net cash used in investing (PP&E, software, dividends from associate) | -35.8 |
| Net cash used in financing (lease principal, loan repayment, dividends paid) | -49.0 |
| **Net change in cash** | **-28.5** |

**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.**

```vega-lite
{
  "$schema": "https://vega.github.io/schema/vega-lite/v5.json",
  "description": "Northfield Outdoor Co. FY2026 bridge from operating profit to net cash from operating activities, USD m (fictional)",
  "width": 420,
  "height": 220,
  "data": {"values": [
    {"step": "1 Operating profit", "amount": 37.4, "type": "Start or total"},
    {"step": "2 Depreciation and amortisation", "amount": 55.3, "type": "Adds cash"},
    {"step": "3 Impairment", "amount": 3.0, "type": "Adds cash"},
    {"step": "4 Provision increase", "amount": 1.2, "type": "Adds cash"},
    {"step": "5 Working capital", "amount": -20.0, "type": "Uses cash"},
    {"step": "6 Income taxes paid", "amount": -6.5, "type": "Uses cash"},
    {"step": "7 Net cash from operating activities", "amount": 70.4, "type": "Start or total"}
  ]},
  "mark": "bar",
  "encoding": {
    "y": {"field": "step", "type": "nominal", "sort": null, "title": null},
    "x": {"field": "amount", "type": "quantitative", "title": "USD m"},
    "color": {"field": "type", "type": "nominal", "title": null}
  }
}
```

**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

<!-- Guidance: Pick one definition per purpose and write it next to every number. The FY2026 results show why: the same company has free cash flow of 33.4 or -8.7 depending on the definition. -->

| ID | Definition | Formula | FY2025 | FY2026 | Use it for |
|---|---|---|---|---|---|
| FCF-1 *(Example)* | CFO (IFRS 18 basis) less capex | 70.4 - 37.0 | 53.4 | 33.4 | Rarely useful alone: excludes interest and lease costs |
| FCF-2 *(Example)* | CFO with interest inside (IAS 7 policy or US GAAP) less capex | 56.3 - 37.0 | 39.5 | 19.3 | Common "reported" free cash flow before leases |
| FCF-3 *(Example)* | FCF-2 less lease principal | 19.3 - 28.0 | 14.5 | -8.7 | Cash available to shareholders and lenders after all store costs; comparable with US GAAP retailers |
| FCFF before new leases *(Example)* | NOPAT + D&A + impairment + provision increase - working capital increase - capex | 28.1 + 55.3 + 3.0 + 1.2 - 20.0 - 37.0 | 49.3 | 30.6 | Intermediate step only: it adds back right-of-use depreciation but charges nothing for new leases, so it overstates cash flow when lease liabilities are counted as debt |
| FCFF, leases as debt *(Example)* | FCFF before new leases less new right-of-use assets (new leases treated like capex) | 30.6 - 44.0 | 19.3 | -13.4 | DCF valuation at a WACC that includes lease liabilities, with lease liabilities deducted in the equity bridge (mba/mba-dcf-valuation-card). If you instead treat leases as operating costs, deduct the full lease payment from the cash flow and leave lease liabilities out of net debt and the WACC |
| FCFE *(Example)* | FCF-2 less lease principal plus net borrowing | 19.3 - 28.0 - 10.0 | 14.5 | -18.7 | Dividend capacity and equity valuation |

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)

<!-- Guidance: Fill each [ ] before you open the answer key. Use the FY2024 and FY2025 balance sheets in mba/mba-three-statements-card. -->

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.

| Indirect method | FY2025 | Direct method | FY2025 |
|---|---|---|---|
| Operating profit | 37.9 | Cash received from customers | [ ] |
| D&A | 50.0 | Cash paid to suppliers | [ ] |
| Increase in receivables | -1.0 | Cash paid to employees | -76.0 |
| Increase in inventories | [ ] | Other operating payments | [ ] |
| Increase in prepayments | -0.4 | Income taxes paid | [ ] |
| Increase in trade payables | [ ] | | |
| Increase in accrued liabilities | 1.2 | | |
| Increase in contract liabilities | [ ] | | |
| Income taxes paid | [ ] | | |
| **Net cash from operating activities** | **[ ]** | **Net cash from operating activities** | **[ ]** |

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)

<!-- Guidance: Classify each item before you compute. Then compute runway: how long the cash lasts at this year's burn. -->

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

| Item | Amount |
|---|---|
| Operating loss | -6.0 |
| Depreciation | 5.0 |
| Share-based compensation expense (non-cash) | 3.2 |
| Trade receivables, opening to closing | 18.0 to 24.0 |
| Inventories, opening to closing | 16.0 to 21.0 |
| Trade payables, opening to closing | 8.0 to 10.4 |
| Deferred revenue (contract liabilities), opening to closing | 4.0 to 6.5 |
| Income taxes paid | 0.2 |
| Purchases of PP&E | 7.5 |
| Capitalised development costs (IAS 38) | 3.0 |
| Interest received on deposits | 1.1 |
| Interest paid on convertible notes / on leases | 0.6 / 0.3 |
| Lease principal paid | 1.8 |
| Proceeds from issue of preferred shares classified as equity | 40.0 |
| Opening cash | 6.2 |

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

<!-- Guidance: Follow the question your cash flow analysis raised. -->

| Next card | Use it when |
|---|---|
| mba/mba-three-statements-card | You need the full statements or the articulation checks |
| mba/mba-ratio-analysis-card | You want cash conversion, the cash conversion cycle and quality-of-earnings screens |
| mba/mba-dcf-valuation-card | You forecast FCFF and discount it |
| mba/mba-npv-irr-card | You evaluate one project's cash flows |
| mba/mba-venture-finance-cap-table-card | You model a start-up's burn, runway and funding rounds |
| mba/mba-financial-accounting-guide | You want the course map, the mini-case and the exam plan |
| finance/13-week-cash-flow-forecast, finance/working-capital-review | You manage cash at work |

## Common mistakes and misconceptions

<!-- Guidance: Read before every exam. Log any mistake in mba/mba-error-log. -->

- **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

<!-- Guidance: Answer from memory, then check the key. Repeat after two days and a week. -->

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

<!-- Guidance: Write down your chosen free cash flow definition so you use the same one in every case and interview. -->

| Item | My entry |
|---|---|
| Confidence with the indirect method (1 to 5) | [ ] |
| Confidence with the direct method (1 to 5) | [ ] |
| My standard free cash flow definition | [ ] |
| Mistakes logged in mba/mba-error-log | [Date and short description] |
| Next review date | YYYY-MM-DD |
| Next card | [mba/mba-dcf-valuation-card / mba/mba-ratio-analysis-card] |

## Sources and further reading

<!-- Guidance: Standards first (numbers and dates checked on the official pages), then research, then textbooks named for further reading only. -->

- 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

<!-- Guidance: Check only after writing your own answers. -->

**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

<!-- Guidance: Add a row when you change basis, definitions or the example company. -->

| Version | Date | Author | Change summary |
|---|---|---|---|
| 0.1 | YYYY-MM-DD | [Your name] | First pass through Worked examples A and B |
| 0.2 | YYYY-MM-DD | [Your name] | *Example:* Rebuilt for a listed retailer's FY2027 report under amended IAS 7 |

## 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.