Statement of cash flows (1): cash from operating activities

Why profit and cash differ

• Depreciation and losses on disposal reduce profit but involve no cash: add them back.
• Profits on disposal increase profit but the cash received belongs in investing activities: deduct them.
• Working capital: an increase in inventories or receivables ties up cash (deduct); an increase in payables means cash has not yet been paid (add). Decreases work the other way.

Examiners report candidates adding profits on disposal and deducting losses: it is the reverse.

The reconciliation layout used by Pearson

Reconciliation (figures in £000)

Interest and tax paid

The amounts paid are rarely the same as the charges.

• Interest paid = finance cost charged + opening accrued interest - closing accrued interest.
• Tax paid = opening tax liability + tax charge for the year - closing tax liability.

If a loan was taken out halfway through the year, only half a year's interest is due (an examiner point).

If you start from profit before tax instead of profit from operations, add back the finance costs first.

Exam reminders

Include the subtotals 'Operating cash flow before working capital changes' and 'Cash generated from operations': examiners report they are often omitted. Use brackets for outflows and label every line.

Worked example

Using the figures in the table: inventories rose from 300 to 345, receivables fell from 260 to 240, payables rose from 190 to 225 (£000). Finance costs were 60 with accrued interest 10 at the start and 15 at the end; tax liability was 120 at the start, the charge 150, and 135 at the end. Find net cash from operating activities.

1. Operating cash flow before working capital changes = 840 + 210 - 30 = 1020
2. Working capital: - 45 + 20 + 35 gives cash generated from operations = 1030
3. Interest paid = 60 + 10 - 15 = 55
4. Tax paid = 120 + 150 - 135 = 135
5. Net cash from operating activities = 1030 - 55 - 135 = 840

Answer: £840000

Check yourself

1. Profit from operations £560,000; depreciation £120,000; loss on sale of equipment £15,000. Calculate operating cash flow before working capital changes.
   Show answer

   £695000. 560,000 + 120,000 + 15,000 = £695,000.

2. Operating cash flow before working capital changes £700,000; inventories increased by £40,000; trade receivables increased by £25,000; trade payables decreased by £10,000. Calculate cash generated from operations.
   Show answer

   £625000. 700,000 - 40,000 - 25,000 - 10,000 = £625,000.

3. The tax liability was £86,000 at the start of the year and £94,000 at the end. The tax charge in the statement of profit or loss was £102,000. How much tax was paid?
   Show answer

   £94000. 86,000 + 102,000 - 94,000 = £94,000.

4. A 10% bank loan of £500,000 was taken out halfway through the year. No interest is accrued at the year end. How much interest was paid in the year?
   Show answer

   £25000. Six months: 500,000 x 10% x 6/12 = £25,000.

5. Profit from operations is £430,000, including a profit of £36,000 on the sale of a vehicle. Depreciation is £75,000. Calculate operating cash flow before working capital changes.
   Show answer

   £469000. 430,000 + 75,000 - 36,000 = £469,000.

6. Why is depreciation added back in the reconciliation?
   • It is a cash inflow
   • It is paid to the tax authority
   • It reduced profit but no cash was paid out
   • It increases the value of assets
   Show answer

   It reduced profit but no cash was paid out. Depreciation is a non-cash expense; the cash went out when the asset was bought.

7. Trade receivables increased during the year. How is this shown?
   • Deducted, because cash from customers is less than sales
   • Added, because sales have increased
   • Ignored, because it is not cash
   • Shown in financing activities
   Show answer

   Deducted, because cash from customers is less than sales. More sales are still unpaid, so cash received is lower than revenue.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting specification (XAC11/YAC11), Issue 2
• Pearson Edexcel IAL Accounting WAC12 Unit 2 mark scheme, October 2022
• Pearson Edexcel IAL Accounting WAC12 examiners' report, October 2022

Last updated 8 November 2026. Spotted a mistake? Tell us.