Classifying cash flows: operating, investing, financing
How to classify a client's cash flows under the indirect method, which items land in the wrong section, and when to type over a calculated figure.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
The cash flow statement is the one primary statement many small-company readers skip, and the one reviewers most often send back. It balances, because it is built to balance, but the director's loan repayment sits in operating activities, the new vehicle bought on credit appears as cash spent, and the profit on selling the old one is counted twice. Each error is small. Together they tell the reader a story about the business's cash that did not happen.
This article covers how to classify a client's cash flows under the indirect method, the items that most often land in the wrong section, and how Achekam's calculated cash flow and a preparer's judgement should work together.
The indirect method, from profit to cash generated by operations
Under the indirect method, the operating section starts from profit and works back to cash:
- Profit before tax.
- Add back or deduct non-cash items: depreciation, amortisation, impairment, the profit or loss on disposals, movements in provisions.
- Adjust for movements in working capital: inventory, trade and other receivables, trade and other payables.
- The result is cash generated from operations.
- Interest and tax paid, presented according to the entity's policy, give net cash from operating activities.
Investing activities show cash spent on and received from long-term assets and investments. Financing activities show cash from and to the providers of capital: loans raised and repaid, lease principal, shares issued, and dividends where that is the policy. ACCA's article on the statement of cash flows explains, assuming no prior knowledge, how to calculate cash flows and where they are presented, and is worth giving to any junior preparing a first cash flow.
Items that commonly land in the wrong section
| Item | Common error | Usual treatment |
|---|---|---|
| Asset bought on credit or under a lease | Shown as cash spent in investing | Not a cash flow when acquired; repayments later in financing |
| Proceeds from selling an asset | Left inside operating through the profit on sale | Gross proceeds in investing; profit removed from operating |
| Loans to or from directors and shareholders | Treated as working capital | Usually financing (from them) or investing (to them) |
| Lease payments | All in operating | Principal in financing; interest per policy |
| Interest and dividends | Inconsistent from year to year | A stated policy, applied every year |
| Tax paid | Netted against the tax charge | Cash actually paid, in operating unless specifically identified with another activity |
| Bank overdraft | Shown as financing | Part of cash and cash equivalents where it is repayable on demand and part of cash management |
Write the client's policy choices, for interest, dividends and the overdraft, into the accounting policies and keep them the same each year.
Non-cash movements to strip out
The indirect method only works if every non-cash movement is removed from the operating section.
Depreciation. Achekam does not calculate depreciation. It presents the depreciation in the trial balance, flags when the charge does not agree with the movement in accumulated depreciation, and lets staff post a year-end adjusting entry. Clear that flag before looking at the cash flow, or the add-back and the asset movement will not reconcile.
Accruals and prepayments. These are working capital: their movement belongs in the receivables and payables adjustments, not as separate operating lines.
Disposals. The change in the asset balance is not the cash received. Remove the profit or loss on disposal from operating, and show the actual proceeds in investing.
How custom statement lines carry into the right cash flow line
Achekam's cash flow statement works its current-year column out from the change in balances. A firm can add its own statement lines and groups and rename any row, and later builds keep those choices. Each custom line still totals into a standard line, so the notes, the cash flow and the iXBRL tags stay consistent.
The practical consequence: a custom line behaves, in the cash flow, like the standard line it totals into. If a firm creates "Loan to director" as a custom line under trade and other receivables, its movement will appear in the receivables working-capital adjustment, which may not be where it belongs. Choose the standard line for a custom line with its cash flow treatment in mind. How custom lines and groups work is covered in custom statement lines and groups.
When a person should type a figure over the calculated one
Staff can type their own figure for any line of the cash flow, and the typed figure then takes priority over the calculated one. That is the right tool when the change in balances does not tell the cash story:
- an asset acquired on credit or through a lease;
- a disposal, where proceeds differ from the change in the asset balance;
- a non-cash settlement, such as a loan converted to equity;
- a reclassification between current and non-current that moved no cash.
Two disciplines go with it. Record why each typed figure was entered, in the working papers. And revisit typed figures whenever the trial balance changes, because a typed figure keeps its priority even when the balances behind it move. Comparatives can come from a person's figures, last year's issued statements or a prior-year set a person reviews; their handling is covered in comparatives and the cash flow column.
Proving it: opening cash plus movements equals closing cash
The final check is arithmetic: opening cash and cash equivalents, plus the net movement from the three sections, must equal closing cash and cash equivalents on the statement of financial position, with the same definition of cash used at both ends.
The Studio builds the draft statements with every figure calculated in code. Staff can also run an automated review of a draft, which lists findings for a person to accept, resolve or dismiss; it is advice only and does not block signing. Separately, the Validation & Math Engine runs fixed, non-AI checks such as double entry and note ties. Do the cash proof yourself as well, and then read the statement as a reader would: does it explain where the year's cash came from and went?
A worked example in words: a transport company buys a truck under an instalment sale agreement and sells an old one. The calculated investing line shows the full change in vehicles. The preparer types over it with the actual sale proceeds received, moves the instalment repayments to financing, removes the profit on sale from operating, and notes each change. The proof agrees to the bank balances.
A checklist for review
Before the cash flow goes to the reviewer: depreciation flag cleared, disposals split into proceeds and profit, non-cash acquisitions excluded, director and shareholder loans classified, typed figures documented, and the cash proof agreed.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
