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Plain‑English explainer of HKAS 7 / IAS 7 for students, junior accountants and non‑specialists who find official standards too dense to read.
This article is based on Hong Kong Accounting Standards (HKAS / HKFRS), which are fully aligned with IAS / IFRS except for minor local tweaks, so the same principles generally apply under IAS / IFRS unless noted otherwise. The goal is to unpack HKAS 7 Statement of Cash Flows (equivalent to IAS 7) using plain English and practical, real‑life examples instead of technical jargon. It is written for students, junior accountants, audit juniors and finance professionals who want to understand not just “what the standard says” but how to actually read and prepare financial statements in line with it.
When you see “the company” or “the entity” below, you can think of any entity that prepares general purpose financial statements under HKFRS / IFRS.
“Where did the cash go?” – why HKAS 7 matters
Many beginners focus almost entirely on the statement of financial position and the statement of profit or loss and other comprehensive income, while barely looking at the statement of cash flows.
But in real life, cash is the company’s bloodstream: a business can show a healthy profit and still run into trouble if it is short of cash.
When investors read annual reports of Hong Kong listed companies, they often notice situations where the company is profitable on paper, but the cash position is tight and liquidity risks start to show.
The natural question is: what exactly is the cash flow statement trying to tell us, and what is the practical value of HKAS 7 / IAS 7?
What You Should Be Able to Do After Reading?
By the end, you should be able to:
- Clearly explain the objective of HKAS 7 / IAS 7 and which entities must prepare a statement of cash flows.
- Distinguish correctly between “cash” and “cash equivalents” and avoid common misunderstandings.
- Understand why certain cash management activities (like moving money between current and time deposits) are not treated as cash flows.
- Grasp the logic behind the three categories: operating, investing and financing activities.
- Appreciate how the cash flow statement adds value in financial analysis and day‑to‑day practice.
1. Objective and scope of HKAS 7 / IAS 7
HKAS 7 Statement of Cash Flows (equivalent to IAS 7) aims to give users information about the inflows and outflows of cash and cash equivalents, so they can assess the entity’s ability to generate cash and its future liquidity and repayment capacity.
This is not just a compliance exercise; it opens a window into the entity’s real cash position.
The standard requires all entities – listed companies, private companies, and even not‑for‑profit organisations – to prepare a statement of cash flows as one of the primary financial statements, presented together with the other main statements.
This reflects a key principle in financial reporting: transparency.
Cash flow information is useful regardless of size or complexity.
It helps users understand the gap between accounting profit and actual cash flows: for example, rising trade receivables mean revenue has been recognised but cash has not yet been collected; cash used to acquire machinery does not hit profit or loss immediately, but it definitely affects the entity’s cash resources.
For investors and management, the cash flow statement acts like a mirror, showing whether performance is backed by “real cash” or just accounting numbers.
For auditors, it is also an important tool to evaluate the quality of profit.
2. Getting the basics right: what counts as cash and cash equivalents?
The first step in understanding a cash flow statement is to be clear about what “cash” and “cash equivalents” actually mean under HKAS 7 / IAS 7.
Under HKAS 7 / IAS 7:
- Cash includes cash on hand and demand deposits that can be used immediately.
- Cash equivalents are short‑term (usually three months or less), highly liquid investments that are readily convertible to known amounts of cash and subject to an insignificant risk of changes in value.
Examples that may qualify as cash equivalents include short‑term time deposits, short‑term treasury bills and certain highly liquid money market funds.
Why the focus on “three months”?
This is a practical line frequently used in applying the standard: if a deposit or bond has a maturity longer than three months, it may still be a good investment, but it is not liquid enough to be treated as a cash equivalent.
A common area of confusion is the treatment of bank overdrafts.
HKAS 7 / IAS 7 distinguishes two situations:
- If the overdraft is short‑term and used as part of day‑to‑day cash management (for example, a fluctuating overdraft linked to an operating bank account), it can be included with cash and cash equivalents in the cash flow statement.
- If it behaves more like a long‑term borrowing, it should be shown as a financing cash outflow instead.
This may sound like a small technical point, but it matters for users trying to understand the entity’s liquidity.
For example, if a company parks a large amount of surplus cash into a six‑month deposit, its “cash” balance will drop, yet its liquidity may still be adequate; if that deposit is wrongly classified as a cash equivalent, it can mislead readers about how much truly liquid cash is available.
3. Internal cash management: why many transfers are not “cash flows”
Students often ask: if the entity moves money from a current account to a time deposit, or converts foreign currency cash into Hong Kong dollars, isn’t that a cash flow?
HKAS 7 / IAS 7 gives a clear answer: such movements are transfers between cash and cash equivalents and are not treated as cash flows.
The cash flow statement is about changes in the total balance of cash and cash equivalents, not about the reshuffling of amounts within that total.
Consider a simple example:
- The entity transfers HKD 5 million from a demand deposit into a three‑month time deposit.
This is just a change in how the entity holds its cash; the total amount of cash and cash equivalents has not changed.
If this were presented as an investing cash outflow, the statement would appear more complicated and less meaningful.
Therefore, HKAS 7 / IAS 7 focuses on transactions that generate or use up cash, such as:
- Receiving cash from customers
- Paying suppliers or employees
- Purchasing assets
- Granting loans
- Repaying borrowings
These are the flows that really change the total amount of cash and cash equivalents.
The underlying logic is that short‑term cash management is different from investing and financing activities.
Cash management involves short‑term allocation of funds to keep liquidity efficient, whereas investing and financing activities change the structure of the business and its capital.
When preparing a statement of cash flows, accountants need to keep this distinction in mind to avoid overstating or understating actual cash movements.
4. The three activity categories: operating, investing and financing
To really read a cash flow statement, you must understand the logic behind its three activity categories.
HKAS 7 / IAS 7 splits cash flows into: operating activities, investing activities and financing activities.
Operating activities – the day‑to‑day “cash engine”
Operating activities are the main revenue‑generating activities of the entity and other activities that are not investing or financing.
Typical operating cash flows include:
- Cash receipts from customers
- Cash payments to suppliers
- Cash payments to employees
- Cash paid for rent or other operating expenses
- Cash paid or received for interest (classification can vary but is often presented here, depending on policy)
This section shows whether the core business is generating positive cash flows – effectively, whether the entity’s operations have a healthy “cash engine”.
In practice, entities commonly use the indirect method: they start from profit before tax and adjust for:
- Non‑cash items such as depreciation and amortisation
- Changes in working capital (e.g. trade receivables, inventories, trade payables)
This reconciles accounting profit to operating cash flow.
Investing activities – using cash to build or realise capacity
Investing activities are mainly about changes in long‑term assets and investments.
Examples include:
- Cash paid to acquire property, plant and equipment
- Cash received from disposing of property, plant and equipment
- Cash paid to acquire equity or debt instruments of other entities
- Cash received from selling such investments
- Cash received from certain investment returns
A common example: cash outflows to buy new machinery will not hit profit or loss in full in the current period, but they definitely reduce cash.
Similarly, selling a building might bring in a large cash inflow, even if the accounting gain or loss is relatively small.
These cash flows reflect the entity’s investment decisions and its strategy for growth or restructuring.
Financing activities – raising and returning capital
Financing activities relate to changes in the size and composition of the entity’s equity and borrowings.
Typical financing cash flows include:
- Cash received from issuing shares
- Cash received from new borrowings
- Cash paid to repay borrowings
- Cash paid as dividends to shareholders
They show how the entity “gets money” (from owners and lenders) and how it “pays back” that money.
If the entity relies heavily on external financing while operating cash flows are consistently negative, this can be a warning sign about debt repayment risk.
In practice, some transactions have mixed characteristics.
For example, lease payments and interest payments may be classified in different ways depending on the entity’s judgment and accounting policy.
HKAS 7 / IAS 7 allows entities to choose the classification that best reflects their operations, provided they apply it consistently and explain it clearly in the notes.
You can think of the three activity types as three cash cycles:
- Operating activities = generating cash in day‑to‑day business
- Investing activities = using cash to enhance or unlock capacity
- Financing activities = obtaining capital and returning it to capital providers
Once you understand this framework, reading any statement of cash flows becomes much easier: you can quickly see which area is consuming the most cash and which area is generating it.
5. Why cash flow information matters for analysis
The statement of cash flows is not just another disclosure requirement; it is a key analytical tool that complements the profit or loss account.
It helps to bridge the timing differences created by accrual accounting.
First, it helps assess liquidity and solvency.
If operating cash flows are consistently positive, the entity is generally able to finance its operations from its own cash generation.
If operating cash flows are negative over a long period and the gap is filled by financing inflows, this may indicate a reliance on external funding to stay afloat.
Second, it sheds light on the quality of profit.
If profit is increasing but operating cash flow is falling, it may indicate that revenue is not being collected in cash, or that trade receivables are growing quickly.
Third, it helps to forecast future cash‑generating ability.
By looking at trends in operating, investing and financing cash flows, users can get a sense of the entity’s investment rhythm and capital strategy, which is especially important for investors.
For example:
- If operating cash flows are steadily positive and there are large cash outflows in investing activities, the entity might be in an expansion phase.
- If there are net cash inflows from investing activities (e.g. from selling assets), it may indicate that the entity is shrinking or restructuring.
These insights often tell you more about the underlying health of a business than profit figures alone, which is why analysts, auditors and examiners pay close attention to cash flow concepts.
6. From reading the statement to understanding the business
Mastering HKAS 7 / IAS 7 is not just about being able to prepare a statement of cash flows; it is about learning how to “read” a company.
Once you grasp the ideas in this standard, you will stop looking only at total assets on the statement of financial position or profit on the income statement.
You will naturally turn to the cash flow statement to see whether operating cash inflows support reported profit, whether investing activities look healthy, and whether the financing strategy appears sustainable.
The cash flow statement is a constant reminder: profit is not the same as cash.
Understanding it means understanding the real financial engine of the entity.
In your work, you can start by asking simple questions in your working papers: “Is this just a transfer within cash and cash equivalents?” or “Does this transaction actually change the total cash and cash equivalents balance?”.
When you read financial statements, try starting with the cash flow statement and ask yourself whether the company is genuinely cash‑rich or only “paper‑rich”.
Key takeaways for students and junior accountants
- Use HKAS 7 / IAS 7 as a framework: whenever you see a transaction, ask whether it changes total cash and cash equivalents, and if so, whether it belongs to operating, investing or financing activities.
- Watch the common pitfalls: misclassifying long‑term deposits as cash equivalents, treating internal transfers as cash flows, or inconsistently classifying interest and lease‑related cash flows.
- In exams, clearly identify whether an item is: (a) cash, (b) cash equivalent, (c) a transfer within cash and cash equivalents, or (d) a genuine cash flow – and explain your reasoning briefly.
- In practice, when reviewing contracts or new transactions, think ahead about how the cash movements will be presented in the cash flow statement and whether they might affect perceived liquidity or leverage.
- When preparing working papers, document judgments around classification (e.g. overdrafts, time deposits, interest, dividends) so that your approach is consistent and can be defended to managers, auditors or regulators.
- As a reader of financial statements, get into the habit of reconciling profit to operating cash flow and asking whether the business model is genuinely self‑funding or living off external financing.
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