Definition

The cash flow statement (formally the "statement of cash flows" under FRS 102 Section 7) is a primary financial statement that reconciles the opening and closing cash balances by presenting movements under three headings: operating activities, investing activities and financing activities. It is required by the Companies Act 2006 for companies above the small company threshold. The cash flow statement removes the effects of accruals-basis accounting to show the actual cash position of the business.

Why this matters for Accounting Principles & Procedures

  • Level 1 knowledge: you must be able to identify the three sections of a cash flow statement and give examples of items within each.
  • A property company can report a profit on its P&L (driven by investment property revaluation gains) whilst simultaneously consuming cash; the cash flow statement reveals this.
  • Assessors use cash flow questions to test whether candidates understand that profit and cash are different concepts, one of the most fundamental points in financial literacy.
  • Surveying professionals advising property investors or developers need to understand cash flow statements to assess a client's liquidity, solvency and ability to fund future investment.

Key principles

A worked example: Brick & Mortar Estates Ltd

Consider Brick & Mortar Estates Ltd, a small UK residential property investment company, for the year ended 31 December 2025.

Operating activities

  • Net rental income received: £96,000
  • Property management fees paid: (£8,400)
  • Insurance and service charges paid: (£6,200)
  • General and administrative expenses paid: (£4,100)
  • Interest paid on mortgage: (£38,400)
  • Corporation Tax paid: (£3,200)
  • Net cash from operating activities: £35,700

Investing activities

  • Purchase of additional investment property: (£320,000)
  • Capital expenditure on existing properties: (£14,500)
  • Net cash used in investing activities: (£334,500)

Financing activities

  • Mortgage drawdown on new property: £256,000
  • Repayment of mortgage capital: (£40,000)
  • Dividends paid to shareholders: (£12,000)
  • Net cash from financing activities: £204,000

Net decrease in cash: (£94,800)
Opening cash balance: £139,800
Closing cash balance: £45,000

Reading the cash flow statement

The company generates positive operating cash flow of £35,700, confirming the rental business is self-sustaining after interest and tax. However, it has invested £334,500 in properties (funded mainly by a £256,000 mortgage drawdown), producing a net cash decrease of £94,800. A reader of only the P&L might see a profitable year if fair value gains were recognised; the cash flow statement reveals the reality of a capital-intensive year largely funded by debt.

The indirect method of presenting operating cash flow

Under FRS 102, operating cash flow may be presented using the indirect method: start with profit before tax, then adjust for non-cash items (depreciation, fair value gains and losses on investment property) and working capital movements. Understanding the indirect method allows a candidate to reconcile P&L profit to the actual cash generated from operations.

Relevant RICS guidance and legislation

  • FRS 102 Section 7 (Statement of Cash Flows) — sets out requirements for preparing and presenting the cash flow statement for UK entities.
  • Companies Act 2006 — requires a cash flow statement as part of annual accounts for companies above the small company threshold.
  • FRS 102 Section 16 (Investment Property) — fair value gains are non-cash and are reversed in operating activities under the indirect method.
  • RICS Rules of Conduct (effective 2 February 2022) — Rule 5 (competent service): advising property investors on liquidity and solvency requires ability to read and interpret the cash flow statement.

Ethics and Rules of Conduct angle

Rule 3 of the RICS Rules of Conduct requires members to act with integrity. A surveying adviser who presents a property company's accounts to a prospective investor or lender without drawing attention to adverse cash flow trends, or who allows a client to believe that reported profit means the business is cash-generative, risks breaching their duty of honest dealing. Rule 5 (competent service) requires members to present a balanced and accurate picture of a client's financial position.

APC-style Q&As

Q (Level 1)What are the three sections of a cash flow statement?

Operating activities (cash generated or consumed by the entity's principal trading activities); investing activities (cash flows from the purchase and disposal of long-term assets); and financing activities (cash flows from debt and equity financing, including loan drawdowns, repayments and dividends).

Q (Level 1)Why is it possible for a profitable company to have a negative cash flow?

Profit is calculated on an accruals basis, recognising income when earned and costs when incurred regardless of cash timing. A company can report profit whilst consuming cash if it is investing heavily, slow to collect debts, or holding large inventory. For a property company, unrealised fair value gains increase reported profit but generate no cash.

Q (Level 2)In the Brick & Mortar Estates Ltd example, why is the fair value gain on investment property excluded from the cash flow statement?

Fair value gains recognised in the P&L under FRS 102 Section 16 are unrealised and represent no cash movement. Under the indirect method, such gains are deducted from profit before tax as a reconciling adjustment to arrive at cash actually generated by operating activities. Cash from a property disposal only appears in the cash flow statement when the property is sold and cash is received.

Q (Level 2)What does a large negative figure in investing activities tell you about a property company?

It indicates the company has deployed significant capital into long-term assets during the period, typically through property acquisition or major capital expenditure. The key question is how the investing outflows are funded: if financed by strong operating cash flows or equity, it is a sign of financial health; if funded entirely by debt, the financing activities section will show large loan drawdowns, increasing financial risk and interest burden.

Q (Level 3)A property investment client is concerned their bank may question their ability to service their mortgage. How would you use the cash flow statement to assess this risk?

(example) I would focus on operating activities to assess cash generated from rental operations before financing costs. The key metric is interest cover: operating cash flow before interest and tax divided by interest payments; most lenders require at least 1.25 times. I would check the financing activities section for near-term mortgage repayments and confirm the company holds sufficient reserves. If reserves are thin and refinancing is imminent, I would recommend the client contact their bank well in advance.