Edexcel A-Level Accounting: Statement of cash flows (YAC11)

This guide covers topic 2.3, Statement of cash flows, in Unit 2 (Corporate and Management Accounting) of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting (XAC11/YAC11) specification, Issue 2, September 2018 (first teaching September 2015). It teaches both outcomes, 2.3.1 and 2.3.2. This is Unit 2 (A2) only content: it counts towards the full International A Level, not the International AS. All businesses and figures are invented, and amounts are in dollars.

Use it with the revision notes and the practice questions. The course hub is Edexcel A-Level Accounting, and the printable checklist lists every outcome. Before you start, a free 10-minute diagnostic shows which areas need most work.

What topic 2.3 covers

Outcome	Skills you need
2.3.1 Statement of cash flows	Prepare a statement of cash flows for a limited company in accordance with International Accounting Standard (IAS) 7
2.3.2 Liquidity	Explain why liquidity matters to a company and use the statement of cash flows to judge it

The specification’s Appendix 6 glossary says examiners use IAS terms and your answers should too. It lists “statement of cash flows” as the IAS term for the older “cash flow statement”, and “cash and cash equivalents” as the current asset heading used for limited companies under IAS 7.

You need two earlier skills. Depreciation and disposals come from principles and double entry. The current ratio and liquid (acid test) ratio come from analysis of accounting statements.

Why profit and cash differ

Profit is measured on the accruals basis. Revenue counts when goods are sold, not when customers pay. Expenses count when they are incurred, not when they are paid. Some charges, such as depreciation, never involve a payment at all. Spending on non-current assets, loan repayments and share issues move cash but do not pass through the statement of profit or loss.

So a company can report a healthy profit and still run short of cash. The statement of cash flows shows exactly where cash came from and where it went during the year.

IAS 7: the key definitions

• Cash is cash on hand and demand deposits.
• Cash equivalents are short-term, highly liquid investments that can be turned readily into known amounts of cash with an insignificant risk of a change in value. As a guide, an investment normally counts only if it matures within about three months of acquisition.
• IAS 7 allows a bank overdraft to be included in cash and cash equivalents. In your answers, treat it as negative cash.

Every cash flow goes under one of three headings.

Heading	What belongs there	Examples
Operating activities	The company’s main revenue-earning activities	Receipts from customers, payments to suppliers and employees, tax paid
Investing activities	Buying and selling long-term assets and investments	Purchase of property, plant and equipment; proceeds from disposals
Financing activities	Changes in the company’s equity and borrowings	Share issues, debenture issues and repayments, dividends paid

IAS 7 gives a choice for interest and dividends. Interest paid may go under operating or financing activities. Interest and dividends received may go under operating or investing activities. Dividends paid may go under operating or financing activities. This guide shows interest paid under operating activities and dividends paid under financing. Whichever you use, label each line clearly.

Transactions that move no cash are left out of the statement altogether. Examples are a bonus issue, a revaluation of property and the transfer of profit to a general reserve. IAS 7 requires significant non-cash investing and financing transactions to be disclosed in the notes instead.

Two ways to show operating cash flows

IAS 7 permits two methods for the operating section, and it encourages the direct method.

• Direct method: list the gross cash receipts and payments (from customers, to suppliers, to employees).
• Indirect method: start from profit and adjust it for non-cash items and changes in working capital.

Both reach the same figure for cash generated from operations. The indirect method is set out in full below because it uses only the statement of profit or loss and two statements of financial position.

Worked example: Fenwold Ceramics plc

Statements of financial position at 31 May (extracts)

	2026	2025
Property, plant and equipment (carrying value)	612,000	540,000
Inventory	96,500	81,300
Trade receivables	72,400	79,900
Cash and cash equivalents	4,300	–
Trade payables	58,700	52,100
Other payables (interest accrued)	1,500	1,800
Tax payable	26,500	21,000
Bank overdraft	–	14,600
6% debentures	100,000	150,000
Ordinary shares of 0.50 each	360,000	300,000
Share premium	64,000	40,000
Retained earnings	174,500	121,700

Other information for the year ended 31 May 2026

• Profit from operations 131,600; finance costs 6,000; tax charge 27,800; profit for the year 97,800.
• Property, plant and equipment at 1 June 2025: cost 800,000, accumulated depreciation 260,000. Depreciation for the year was 84,000.
• Equipment that cost 70,000, with accumulated depreciation of 48,000, was sold for 15,000.
• 50,000 of debentures were repaid on 1 June 2025. Dividends paid were 45,000.

Step 1: the workings

Disposal. Carrying value = 70,000 − 48,000 = 22,000. Proceeds of 15,000 give a loss of 7,000.

Purchases of property, plant and equipment. Build the year-end figures, then find the missing purchase.

Accumulated depreciation 31 May 2026 = 260,000 - 48,000 + 84,000 = 296,000
Cost 31 May 2026 = carrying value + accumulated depreciation
                  = 612,000 + 296,000 = 908,000
Purchases = 908,000 - (800,000 - 70,000) = 178,000

Tax paid = opening payable + charge − closing payable = 21,000 + 27,800 − 26,500 = 22,300.

Interest paid = 1,800 + 6,000 − 1,500 = 6,300.

Share issue. Shares rose by 60,000 and share premium by 24,000, so cash received was 84,000 (120,000 shares at 0.70 each).

Dividends check. 121,700 + 97,800 − 45,000 = 174,500, which agrees with closing retained earnings.

Step 2: the statement

Fenwold Ceramics plc
Statement of cash flows for the year ended 31 May 2026

Cash flows from operating activities
Profit from operations                               131,600
Adjustments for:
  Depreciation                                        84,000
  Loss on disposal of equipment                        7,000
  Increase in inventory                              (15,200)
  Decrease in trade receivables                        7,500
  Increase in trade payables                           6,600
Cash generated from operations                       221,500
  Interest paid                                       (6,300)
  Tax paid                                           (22,300)
Net cash from operating activities                   192,900

Cash flows from investing activities
  Purchase of property, plant and equipment         (178,000)
  Proceeds from sale of equipment                     15,000
Net cash used in investing activities               (163,000)

Cash flows from financing activities
  Proceeds from issue of ordinary shares              84,000
  Repayment of debentures                            (50,000)
  Dividends paid                                     (45,000)
Net cash used in financing activities                (11,000)

Net increase in cash and cash equivalents             18,900
Cash and cash equivalents at 1 June 2025             (14,600)
Cash and cash equivalents at 31 May 2026              4,300

Why each adjustment has its sign

• Depreciation and a loss on disposal were deducted in arriving at profit but no cash left the business, so add them back. A profit on disposal is deducted, because the full proceeds appear under investing.
• More inventory or more receivables means cash is tied up, so deduct the increase. A fall releases cash, so add it.
• More trade payables means the company has held on to cash it owes, so add the increase. A fall in payables is deducted.
• If you start from profit before tax instead, add back finance costs before the other adjustments, then deduct the interest actually paid lower down.

The final line must agree with the cash and cash equivalents figure in the closing statement of financial position. If it does not, an adjustment or a working is wrong.

The direct method for the same company

Suppose Fenwold’s revenue was 1,240,000 (all on credit), cost of sales was 744,000, and its other operating expenses (excluding depreciation and the loss on disposal) were 273,400, all paid in the year.

Receipts from customers = 79,900 + 1,240,000 - 72,400   = 1,247,500
Purchases               = 744,000 + 96,500 - 81,300     =   759,200
Payments to suppliers   = 52,100 + 759,200 - 58,700     =   752,600
Payments for expenses                                    =   273,400
Cash generated from operations = 1,247,500 - 752,600 - 273,400 = 221,500

The figure matches the indirect method exactly. Interest paid and tax paid then follow as before.

Liquidity and why it matters (2.3.2)

Liquidity is a company’s ability to pay its debts as they fall due. A company that cannot pay suppliers, employees, lenders or the tax authority on time can be forced to stop trading, however profitable it looks on paper.

Liquidity matters because:

• Suppliers may stop credit or demand cash on delivery, which disrupts production.
• Lenders may refuse new borrowing, raise interest rates or demand repayment.
• Employees expect wages on time; missed payments damage morale and output.
• Dividends need cash as well as distributable reserves, so shareholders are affected.
• A company with no cash buffer cannot take up opportunities, such as a bulk discount.
• In the worst case, creditors can force the company into liquidation.

A business that expands faster than its cash allows (overtrading) shows the danger: rising revenue and profit, but inventory and receivables swallow the cash, and the overdraft grows.

Reading Fenwold’s statement for liquidity

Measure	2026	2025
Current ratio	2.00 : 1	1.80 : 1
Liquid (acid test) ratio	0.88 : 1	0.89 : 1

2026: current ratio = 173,200 / 86,700 = 2.00 : 1
      liquid ratio  = (173,200 - 96,500) / 86,700 = 0.88 : 1

What the statement adds to the ratios:

• Operating activities produced 192,900, almost twice the profit for the year of 97,800, because depreciation is a large non-cash charge. Core trading generates cash.
• That operating cash more than covered the 178,000 of new equipment, so the company invested without borrowing more.
• The share issue covered the debenture repayment and most of the dividend.
• The overdraft of 14,600 has been cleared. The current ratio improved, but the liquid ratio stayed just below 1 : 1 because the extra current assets went into inventory.

A judgement follows from this: Fenwold’s liquidity is adequate and improving, but the closing cash balance of 4,300 is thin. Watching inventory levels would protect the liquid ratio.

Ways a company can improve liquidity

• Collect debts faster (shorter credit terms, early settlement discounts).
• Hold less inventory.
• Negotiate longer credit from suppliers.
• Issue shares or debentures, or sell surplus non-current assets.
• Lease rather than buy equipment, or delay capital spending.
• Reduce or postpone dividends.

Each has a cost. Faster collection may lose customers; delaying suppliers may lose discounts or goodwill.

Common errors

• Putting the tax charge or the interest charge in the statement instead of the amount paid.
• Showing the carrying value of a disposal under investing activities instead of the sale proceeds.
• Adding a profit on disposal back to profit.
• Getting working capital signs backwards: an increase in receivables is a deduction.
• Treating a bonus issue or a property revaluation as if cash moved.
• Forgetting the share premium when calculating cash raised by a share issue.
• Treating an opening overdraft as positive cash in the final reconciliation.
• Describing liquidity with ratios alone, without using the cash flows to explain why it changed.

Next steps

Condense the method with the revision notes, then test yourself with the practice questions. For exam technique across the whole course, see Edexcel IAL Accounting exam preparation.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting (XAC11/YAC11) specification, Issue 2, September 2018, first teaching September 2015, published by Pearson Education Limited. Unit 2, topic 2.3 Statement of cash flows (outcomes 2.3.1 and 2.3.2), and Appendix 6: Glossary of International Accounting Standards (IAS) terminology.