TUTWPE No 127

Preparation and Analysis of Cash Flow Statements:

The Net Profit Approach and Operating Profit
Approach
Jaan Alver
Department of Accounting at Tallinn University of Technology
101 Kopli, 11712 Tallinn, Estonia
Telephone + 372 620 4006; Fax: + 372 620 4007
E-mail: jaan.alver@ttu.ee

Abstract
A cash flow statement is required as part of a complete set of financial statements
prepared in conformity with IFRS as well as US GAAP for all business enterprises.
IAS 7 lays down a formal structure for the cash flow statement. Cash flows
should be classified under the following three standard headings: Operating activities,
Investing activities, Financing activities.
The classification of cash flows amo ng operating, investing and financing
activities is essential to the analysis of cash flow data. Net cash flow (the change in cash
and equivalents during the period) has little informational content by itself; it is the
classification and individual components that are informative. Although the
classification of cash flows into the three main categories is important, it should be
mentioned that classification guidelines are arbitrary. IAS 7 has not indicated how to
classify certain items that might fit logically in more than one of the major categories of
the statement of cash flows. Examples: 1) Interest and dividends received can be
presented as an operating activity, despite their close association with other activities
presented as investing activities. 2) Interest and dividends paid can be presented as an
operating activity, despite their close association with other activities presented as
financing activities.
Additional troubles arise from case that there is no standard definition of
operating activities and consequently, cash flows from operating activities. Both IASB
and FASB have taken position that operating activities are activities that are not
investing or financing activities. At the same time the opinion that the association of a
cash flow with profit is the primary criterion for classifying the flow as operating, is
expressed. The examples illustrate the influence of the differences in the classification
of cash flow data on net cash from different kinds of activities.
Journal of Economic Literature Classification Numbers: M41

39

Keywords: cash flows, IAS 7, SFAS 95.

Introduction
The subjectivity of conventional accounting has become a matter for persistent debate in
the academic and professional literature. Cash flow accounting (CFA) is a
straightforward information system that avoids complex issues of conventional
accounting. Not surprisingly, cash flow statements (CFSs) have become important
sources of information for users. Today, the clear consensus of national and
international accounting standard setters is that CFS is a necessary component of
complete financial reporting. A cash flow statement is required as part of a complete set
of financial statements prepared in conformity with IFRS as well as US GAAP for all
business enterprises.
The purpose of this paper is to provide users with a guide which will assist
them in the preparation of cash flow statements and in particular provide a practical
approach to the problems which may be encountered in implementing IAS 7.

1. About Terminology
It is clearly fundamental for understanding cash flow statements that the reader should
be familiar with terms like cash flow, operations, investing activities, financing
activities and so on. Few analytical terms are more widely used and, at the same time,
less understood than the term cash flow. Professor Bernstein notes: Standing alone
and unqualified, the term cash flow is in its literal sense, meaningless. (Bernstein,
1989). The author of this paper shares that opinion. An analysis of accounting and
finance literature shows that there is no standard definition of cash flow. Cash flow
has been defined as

movement of money into and out of a business (The Oxford Dictionary for the
Business World, 1993)
the movement of money into (cash inflow) and out of (cash outflow) a business
(Bannock and Manser, 1990)
the movement of cash into and out of a business (Hussey, 1995)
the money coming into a business from sales and other receipts and going out
of the businesses in the form of cash payments to suppliers, workers, etc (Pass,
Lowes, Pendleton and Chadwick, 1995)
the amount of money flowing through an organisation in a given period. A
companys cash flow is equal to its trading profit plus any new money raised
through a share issue or a loan during the period (Hindle, 1998)
the amount of cash being received and expended by a business (A Concise
Dictionary of Business, 1991)
the amount of cash being received and expended by a business (A Dictionary
of Finance, 1993)
40

the amount of cash generated from a particular business activity or project

(Westbrook, 1997)
what is taken in minus what is paid out in a given time period (Shafritz and
Oran, 1990)
the receipts and payments made by a business (Moles and Terry, 1999)
the actual net cash, as opposed to accounting income, that flows into (or out of)
a firm during some specified period. It includes net income plus depreciation
and other noncash charges (Oldham, 1993)
the reported net income of a firm, plus depreciation, depletion, amortisation,
and extraordinary charges to reserves not paid in cash (Caruth and Stovall,
1994).
a company adds the annual depreciation charge for fixed assets to its earnings
after interest, taxes, and preferred dividends (Shook and Shook, 1990)
net change in cash position during a period (Terminology for Accountants,
1992)

According to IAS 7 para. 6, cash flows are inflows and outflows of cash and
cash equivalents.
Often writers when referring to cash flow mean cash generated by operations.
At the same time the meaning and content of the term operating activities
(operations) remains debatable1 .

2. The Structure of the Cash

Classification of Cash Flows

Flow

Statement

and

The IASB rules on the cash flow statement are set out in two standards: IAS 1 and
IAS 7. IAS 7 lays down a formal structure for the cash flow statement. Cash flows
should be classified under the following three standard headings:

Operating activities;
Investing activities;
Financing activities.

Therefore the cash flow statement is based on an activity format which classifies cash
inflows and outflows in terms of operating, investing and financing activities. The
classification of cash flows into operating, investing and financing activities is essential
for the analysis of cash flow data. Net cash flow (the change in cash and equivalents
during the period) has little informational content by itself; it is the classification and
individual components that are informative. According to IAS 7, classification by
activity provides information that allows users to assess the impact of those activities on
the financial position of the enterprise and the amount of its cash and cash equivalents.
This information may also be used to evaluate the relationships among those activities
(IAS 7, para. 11).
The most important section of CFS is cash flows from operations or
operating activities. In accounting literature it is possible to find different explanations
of operating activities (operations):
1)
Operating activities are principal revenue-producing activities of an enterprise
1

Different interpretations of operating activities will be examined further.

41

2)
3)

4)

5)

6)

and include delivering or producing goods for sale and providing services
(Epstein and Mirza, 2003, p. 129).
Operating activities encompass all the earning-related activities of the
enterprise (Bernstein, 1989, p. 408).
The section of cash flows from operating activities should display cash flows
from transactions that affect operating income, and transactions other than
investing and financing activities (Business Accounting Deliberation Council,
1998).
Operating activities are generally the cash effects of transactions and other
events relating to operating or trading activities (Wood and Sangster, 1999, p.
243).
Operating activities are the principal revenue-producing activities of the
enterprise and other activities that are not investing or financing activities (IAS
7, para. 6).
Operating activities include all transactions and other events that are not
defined as investing or financing activities. Operating activities generally
involve producing and delivering goods and providing services (i.e.,
transactions that enter into the determination of net income) (SFAS 95,
para. 21).

Both IASB and FASB have taken the position that operating activities are
activities that are not investing or financing activities. At the same time, the opinion that
the association of a cash flow with profit is the primary criterion for classifying the flow
as operating, is expressed. So, in general, operating activities are the major profitdirected activities of a company that eventually enter into the determination of profit.
The question is: which kind of profit?
Although the IASB separates operating activities from the category of financing
activities, they show the internal generation of cash and therefore represent a source of
financing.
Investing activities. This area lists all the cash used or provided by the
purchase and sale of income -producing assets. Activities in this category involve major
changes in total assets and asset composition.
Financing activities. This section measures the flow of cash between a firm
and its owners and creditors. Activities in this category involve transactions with
creditors and owners.
Although the classification of cash flows into the three main categories is
important, it should be mentioned that classification guidelines are arbitrary. IAS 7 has
not indicated clearly how to classify certain items that might fit logically in more than
one of the major categories of the statement of cash flows. Differences in treatments of
some items of CFS have set up a necessity to formulate explicit criteria for the
classification of items on CFSs.

3. Two Approaches in the Treatment of Operating Cash

Flows
A typical format of the multiple-step income statement divides the income statement
into operating and nonoperating sections and would contain the following components:
42

I Operating section.
Includes the revenues and expenses of the companys primary operations
A. Revenue (sales).
B. Cost of goods sold or service provided.
C. Selling expenses.
D. General and administrative expenses.
E. Other operating expenses.

II Nonoperating section.
Income from investments, gains and losses from the sale of operating assets, interest
revenue, and interest expense are reported as arising from nonoperating activities.
The operating section includes sales, COGS, and operating expenses, while
nonoperating section includes revenues, gains, expenses, and losses stemming from
activities that are not part of the main activity of the business.
Therefore, according to the income statement operating activities are related to
the transactions and other events entering into the determination of operating profit.
As its name implies, CFS is a flow statement, like the income statement. The
format of CFS is grounded on the same idea to classify activities as operating and
nonoperating (the latter are subclassified as investing and financing activities).
Interpreting CFS requires an understanding of two relations:

the relation between profit (net profit or operating profit) and cash flows from
operations;

the relation between the net cash flows from operating, investing, and
financing activities.

Operating activities in CFSs can be treated as inflows and outflows of cash related to
the transactions entering into the determination of
1) net profit;
2) net operating profit.
Consequently, depending on choice, net operating cash flow should
1) highlight the differences between operating profit and net cash flow from
operating activities;
2) highlight the differences between net profit and net cash flow from operating
activities.
It is worth mentioning that these two versions are based on different concepts
of operating activities. The first concept could be denominated as net profit approach
and the second one as operating profit approach.
The conversion process classifies the income statements operating section into
its major components and determines cash collections or payments for each of them. It
clearly appears from the direct method of preparing CFS (especially if the so-called
modified indirect method or semi-direct method has been used). Under the indirect
method of preparing CFS the reconciliation of net profit with cash flows from
operating activities is somewhat misleading because the operating activities (and
therefore, the content of operating sections) on two financial statements are treated

43

differently (and therefore, content of operating sections on the income statement and
CFS is different).
Despite the endless confusion about the concept of operations and about
different aspects of operations, in our opinion the treatment of an item in the income
statement should determine its classification in the cash flow statement2 . The only
reconciliation of operating profit with cash flows from really operating activities
provides the link between the operating sections of two financial statements.

4. The Main Differences in the Classification of Cash Flows

Different treatments of operating activities and operating cash flows result in
differences in classifications. For example, there is little worldwide consensus as to the
classification of interest and dividends paid and received in CFS. The classification of
interest and dividends paid and received is solved very differently in various national
standards. Interest paid can be considered as:

operating cash outflow (because it enters into the determination of net profit);

financing cash outflow (because it is the cost of obtaining a financial resource).

Dividends paid may be classified as either:

operating cash outflows (thereby assisting users to determine the enterprises

ability to make dividend payments out of operating cash flows);

financing cash outflows (since they are a cost of obtaining financial resources).
Dividends and interest receivable may be considered as either:

operating cash inflows (since they enter into the determination of net profit);

investing cash inflows (since they represent a return on investments).

These classification problems point out the complexity of financial statement
classification and the fact that the terminology used in CFS does not correspond
precisely to the more early terminology that has been developed for the income
statement. In the UK the problem is solved by adding a fourth category of cash flows:
returns on investment and servicing of finance but this is not the case in other countries.

USA

New Zealand

Interest paid

Operating
activity

Financing
activity

South
Africa
Operating
activity

IAS 7

Interest
received

Operating
activity

Investing
act ivity

Operating
activity

Operating activity
or
investing activity

Investing
activity

Dividends
paid

Financing
activity

Financing
activity

Operating
activity

Financing activity
or
operating activity

Financing
activity

Dividends
received

Operating
activity

Investing
activity

Operating
activity

Operating activity
or
investing activity

Investing
activity

Operating activity
or
financing activity

Appendix 1 to
IAS 7
Operating
activity

Of course, it does not mean that an analyst should not reclassify the information in the cash flow statement.

44

According to SFAS 95 interest received, dividends received, and interest paid

are all classified as operating activities, while dividends paid are classified as financing
activities. This different treatment for dividends paid relates, in part, to the fact that
dividends paid do not appear in the accrual income statement, whereas dividends and
interest received (revenues) and interest paid (expense) do. Excluding dividends paid
from the operating activities section simplifies the reconciliation of operating cash flows
with net profit. This treatment separates investment returns and interest payments from
the sources of these activities, the purchase and sale of investments which are disclosed
as investing activities, and the sale and retirement of debt which are disclosed as
financing activities. As a result, the presentation of dividends and interest received and
interest paid on CFS is not consistent with their presentation on the income statement.
Cash flow statements prepared according to the requirements of SFAS 95 do not fully
separate operating activities from financing activities since some financial revenues
(such as interest revenue and investment income) and financial expenses (such as
interest expense) are included in the calculation of cash from operations.
Many professionals have found these different treatments of interest and
dividends (and dividends received vs dividends paid) inconsistent and hard to defend.
The FASB cash flow pronouncement, SFAS 95, illustrates that the setting of an
accounting standard is not a science, but is a balancing act with the differing opinions
of users and preparers being weighed against one another and the considerations of the
cost of implementation being weighed against the potential benefits. Since standard
setting is a balancing act, not all interested parties will agree on the final outcome. In
fact, three of the seven members of the Financial Accounting Standards Board dissented
to the issuance of SFAS 95. They believed that interest payments should be classified as
an outflow from financing rather than as a cash outflow from operations. The same
three members also would have classified interest and dividend receipts under investing
rather than operations.
In South Africa interest and dividends received as well as paid are classified as
operating outflows. Therefore the section of operating activities includes an item
(dividends paid) which has no influence on net profit 3 .
New Zealands standard classifies interest and dividend payments as financing
outflows and interest and dividends received as investing inflows which is consistent
with their presentation on the income statement but it should be emphasised that in this
case the net operating cash flow cannot be treated as cash-based equivalent to net profit.
IASB has not taken stand on the case it is CFSs preparers choice how to
classify interest and dividends. The illustrative example in Appendix 1 to IAS 7 (which
does not form part of the standard) should illustrate the application of the standard to
assist in clarifying its meaning. Unfortunately, it does not make the situation clearer.
First of all, the illustrative example in Appendix 1 to IAS 7 is at variance with
paragraph 20 of IAS 7, which states that under the indirect method, net cash flow from
operating activities is determined by adjusting net profit or loss. Also, the presence of
such an item as cash generated from operations is worth mentioning in addition to net
cash from operating activities in the operating section of illustrative CFS while the
former is also a net amount. In the illustrative example interest paid is classified as an
operating activity, while interest received and dividends received are classified as
investing activities and dividends paid as a financing activity. It means that in the
classification of interest and dividends two different approaches have been used
3

It should be noted that due to the originality of Estonian tax legislation it will not be the case in Estonia.

45

interest and dividends received have been classified depart of their association with
investment activities, whereas interest paid has been classified depart of its association
with the determination of net profit. Such a classification is supported heavily by
Flower (Flower, 2002 p. 483):
No distinction is made between financial assets and tangible assets (such as
machines) in classifying their costs as investment cash flows. The return from
the investment in machines is reported as operating cash flow. For consistency,
the return on the investment in financial assets (the interest and dividend
received) should also be reported as operating cash flow. Having classified
interest and dividends received as operating cash flows, it seems natural to
classify interest and dividends paid in a similar fashion, particularly as an
increase in interest paid is often coupled with an increase in interest received.
The author disagrees with Flower and supports the position taken by Nurnberg
and Largay (1998) claiming that interest payments are considered to be financing cash
flows in financial management theory.
Interest paid and dividends paid are payments to providers of financial resources.
Financial decision making emphasises the similarity of interest and dividend
payments interest is paid for the use of debt capital, whereas dividends are paid for the
use of equity capital.
An extreme case of interest payments distorting cash flow from operations
appears in the 1991 cash flow statement for Westinghouse. The reported cash flow was
$703 million but that was after $1.006 billion of interest payments. If these interest
payments had been classified as financing outflows, the cash flow from operations
figure, before tax, would have been $1.709 billion (Penman, 2001, p. 317).
The peculiarity of treating interest as an operating flow can be seen in the case
of zero coupon or deep discount debt. The repayment of the principal at face value is a
financing flow, but the difference between the face value and the issue amount (the
issue discount) should be treated as an operating cash flow at maturity rather than part
of the repayment of principal. So repayment of debt reduces operating cash flow.
Accordingly, in 1990 Turner Broadcasting System deducted $206.1 million of issue
discounts on zero coupon senior notes repaid in calculating an operating cash flow of
$25.8 million (Penman, 2001, p. 317). This is correct accounting according to
US GAAP, but the reported operating cash flow is an 89 percent distortion of the actual
$231.9 million number.
It is worth noting that such a classification is strongly supported by the
Accounting Standards for Consolidated and Parent-Only Cash Flow Statements
(Business Accounting Deliberation Council 1998): Interest and dividends should be
displayed by either of the following methods:
a. Interest and dividends received and interest paid are displayed in the section
of cash flows from operating activities, and dividends paid are displayed in the
section of cash flows from financing activities.
b. Interest and dividends received are displayed in the section of cash flows
from investing activities, and interest and dividends paid are displayed in the section of
cash flows from financing activities.
In the authors opinion different approaches in treatments of interest received
and paid as well as interest and dividends paid are not justified and acceptable. Given
46

the availability of alternative modes of the presentation of interest and dividends

received, and of interest paid, it is particularly critical that the policy adopted be
followed consistently.

5. Illustrative Examples
Simply reporting on cash flow is not enough. It is also necessary to analyse cash flow
statements. The net change in cash is essentially meaningless; a firm can sell assets or
incur liabilities to improve its cash position at the end of an accounting period (often
called window dressing). What is important is the trend in the components of cash
flow and the relationship among them. Investors can avoid a lot of bad investments if
they analyse a companys cash flows (especially operating cash flows).
In the analysis of the CFS, each of the three principal segments should be
reviewed separately since each focuses on a distinct part of business activities. Different
combinations for classification of interest and dividends received as well as interest and
dividends paid and the influence of differences in classification on cash flow data
should be taken into account.
According to standards (IAS 7, SFAS 95), cash flows (or to be more exact,
operating cash flows) can be presented by either the direct method (also called direct
approach, gross method, income statement method, income statement approach, inflowoutflow method, receipts and disbursements method) or the indirect method (also
called indirect approach, net method, reconciliation method, reconciliation approach,
net income approach). It should be mentioned that IAS 7 offers an alternative way of
presenting the cash flows from operating activities which could be referred to as the
modified indirect method (Epstein and Mirza, 2003, p. 134) or semi-direct method
(Stolowy and Lebas, 2002, p. 533). Under this method the starting point is net sales (and
not net profit or operating profit as under the pure indirect method) followed by other
revenue and expense items as reported in the income statement and cash flows are
derived by making adjustments to income statement items. It means that CFS prepared
under the semi -direct method is essentially a cash-basis income statement. Because
the semi-direct method links the cash flow statement with both the firms income
statement and balance sheet, this format is very informative. It will be used in the
following examples to illustrate the influence of the differences in the classification of
cash flow data on net cash from different kinds of activities. Initial data for all examples
are the same (all amounts in euros).
Example 1. Net profit approach. Cash flows are classified according to US GAAP
(SFAS 95). Interest paid as well as interest and dividends received are considered to
represent operating cash flows. Payment of dividends is classified as financing activity.
Cash flows from operating activities
Cash receipts from customers
Cash paid to suppliers
Cash based gross profit
Cash paid for operating expenses
Cash based operating profit
Interest paid

30 150
(23 700)
6 450
(5 500)
950
(270)
47

Interest received
Dividends received
Income taxes paid
Net cash flow from operating activities (cash based net
profit)

200
400
(1100)
180

Cash flows from investing activities

Acquisition of interest in Company X
Purchase of equipment
Proceeds from sale of equipment
Net cash flow from investing activities

(260)
(250)
20
(490)

Cash flows from financing activities

Proceeds from issuance of shares
Proceeds from long term borrowings
Payment of finance lease liabilities
Dividends paid
Net cash flow from financing activities

250
250
(90)
(400)
10

Net cash flow

Cash and cash equivalents at beginning of period

(300)
370

Cash and cash equivalents at end of period

70

It should be noted that if the indirect method were used, the starting point
would be net profit. Therefore the classification used was applied in the frames of the
net profit approach.
Example 2. Cash flows are classified according to New Zealands GAAP. Interest and
dividends received are considered to represent investing cash flows. Payment of interest
and dividends is classified as financing activity.
Cash flows from operating activities
Cash receipts from customers
Cash paid to suppliers
Cash based gross profit
Cash paid for operating expenses
Cash based operating profit
Income taxes paid
Net cash flow from operating activities

30 150
23 700
6 450
(5 500)
950
(1100)

Cash flows from investing activities

Acquisition of interest in Company X
Purchase of equipment
Proceeds from sale of equipment
Interest received
Dividends received
Net cash flow from investing activities

(260)
(250)
20
200
400

(150)

110

Cash flows from financing activities

Proceeds from issuance of shares
Proceeds from long term borrowings
Payment of finance lease liabilities

250
250
(90)
48

Dividends paid
Interest paid
Net cash flow from financing activities

(400)
(270)
(260)

Net cash flow

(300)

Cash and cash equivalents at beginning of period

370

Cash and cash equivalents at end of period

70

It should be noted that if the indirect method were used, the starting point
would be operating profit. Therefore the classification used was applied in the frames of
the operating profit approach.
Example 3. Cash flows are classified according to Appendix 1 to IAS 7. Interest paid is
classified as an operating activity. Interest and dividends received are considered to
represent investing cash flows. Payment of dividends is classified as a financing
activity.
Cash flows from operating activities
Cash receipts from customers
Cash paid to suppliers
Cash based gross profit
Cash paid for operating expenses
Cash based operating profit
Interest paid
Income taxes paid
Net cash flow from operating activities

30 150
(23 700)
6 450
(5 500)
950
(270)
(1100)

Cash flows from investing activities

Acquisition of interest in Company X
Purchase of equipment
Proceeds from sale of equipment
Interest received
Dividends received
Net cash flow from investing activities

(260)
(250)
20
200
400

(420)

110

Cash flows from financing activities

Proceeds from issuance of shares
Proceeds from long term borrowings
Payment of finance lease liabilities
Dividends paid
Net cash flow from financing activities

250
250
(90)
(400)
10

Net cash flow

(300)

Cash and cash equivalents at beginning of period

Cash and cash equivalents at end of period

370
70

It should be noted that if the indirect method were used, the starting point
would be operating profit. Therefore the classification used was applied in the frames of
the operating profit approach.

49

Example 4. This is the case in South Africa. Cash flows are classified according to one
of the possible ways derived from IAS 7. Interest and dividends paid as well as interest
and dividends received are considered to represent operating cash flows.
Cash flows from operating activities
Cash receipts from customers
Cash paid to suppliers
Cash based gross profit
Cash paid for operating expenses
Cash based operating profit
Interest paid
Interest received
Dividends received
Income taxes paid
Cash based net profit
Dividends paid
Net cash flow from operating activities

30 150
(23 700)
6 450
(5 500)
950
(270)
200
400
(1100)
180
(400)

Cash flows from investing activities

Acquisition of interest in Company X
Purchase of equipment
Proceeds from sale of equipment
Net cash flow from investing activities

(260)
(250)
20

Cash flows from financing activities

Proceeds from issuance of shares
Proceeds from long term borrowings
Payment of finance lease liabilities
Net cash flow from financing activities

250
250
(90)

(220)

(490)

410

Net cash flow

(300)

Cash and cash equivalents at beginning of period

370

Cash and cash equivalents at end of period

70

It should be noted that if the indirect method were used, the starting point
would be net profit. Therefore the classification used was applied in the frames of net
profit approach.
The differences in total amounts by subclassifications are shown in the
following table:
Variant
1
2
3
4

Net cash flow from Net cash flow from Net cash flow from
operating activities investing activities financing activities
180
(150)
(420)
(220)

(490)
110
110
(490)

10
(260)
10
410

Net cash flow

(300)
(300)
(300)
(300)

Comments. An analysis is complicated because the operating-nonoperating distinction

is merely one of definitions or a convenience. Dependent on the differences in the
classification of cash flows net cash flow from operating activities varies from the
50

positive sum of 180 to the negative amount of 420, net cash flow from investing
activities from the positive sum of 110 to the negative amount of 490 and net cash flow
from financing activities from the positive sum of 410 to the negative amount of 260. At
the same time, cash-based amounts of gross profit, operating profit and net profit remain
invariable (EUR 6450, EUR 950 and EUR 180, respectively). The respective accrualbased amounts can be obtained from the income statement. Comparative cash-based and
accrual-based data make it possible to apply the concept of earnings quality 4 and
calculate the variety of ratios to characterise the quality of profits.

Summary
The paper focuses on the statement of cash flows that recasts the financial statement
data provided by the accrual process. It discusses the use and analysis of the information
provided by the cash flow statement.
Three important areas that affect cash flows are operations, financing, and
investing. Not surprisingly, they provide the structure for both the preparation and
interpretation of the cash flow statement. Although the classification of cash flows into
the three main categories is important, it should be mentioned that classification
guidelines are arbitrary. IAS 7 does not prescribe how interest and dividends received
and paid should be classified. Rather, IAS 7 requires cash flows from interest and
dividends received and paid to be disclosed separately and classified in a consistent
manner fro m period to period as operating, investing or financing activities. The
opinion that the treatment of an item in the income statement should determine its
classification in the cash flow statement is expressed in this paper. For classification of
operating cash flows, preparing and analysis of cash flow statements two approaches
(net profit approach and operating profit approach) are recommended.

References
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A Dictionary of Finance. 1993. Oxford: Oxford University Press.
Bannock, G. and Manser, W. 1990. The Penguin International Dictionary of Finance. London:
Penguin Books.
Bernstein, L.A. 1989. Financial Statement Analysis: Theory, Application and Interpretation, 4th
edn. Homewood, IL: IRWIN.
Business Accounting Deliberation Council. 1998. Accounting Standards for Consolidated and
Parent-Only Cash Flow Statements. March 13, 1998.
Caruth, D. L. and Stovall, S. A. 1994. NTCs American Business Terms Dictionary. Lincolnwood,
IL: National Textbook Company.
DIRECTORATE-GENERAL XV, Internal Market and Financial Services. Cash Flow
Statements: Document of the Accounting Advisory Forum. XV/6008/94 EN.
Epstein, B. J. and A. A. Mirza. 2003. IAS 2003: Interpretation and Application of International
Accounting Standards. Hoboken, NJ: John Wiley & Sons.
FASB. 1987. The Statement of Cash Flows. Statement of Financial Accounting Standards No. 95.
Stamford, Conn.: FASB.
Flower, J. 2002. Global Financial Reporting. Hampshire: PALGRAVE.
4

The concept of earnings quality is discussed for example by Gallinger and Healey (1991).

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