IFRS 18 is usually discussed as a reform of the income statement. From annual periods beginning on or after 1 January 2027, its consequential amendments to IAS 7 will affect the statement of cash flows too. Companies that currently classify interest paid within operating activities will see a sizeable change in one of the most closely watched measures of cash generation. The revised rules should make comparisons across companies cleaner, while requiring investors to read operating cash flow slightly differently, particularly where borrowing costs are large.
Take a manufacturer that generates $140 million in cash from its operations before interest. It has bank borrowings and pays $30 million of interest during the year. Under its current IAS 7 accounting policy, that payment sits within operating activities, leaving net operating cash flow of $110 million. After the IAS 7 amendments take effect, a company of this type will normally classify the $30 million as financing, while the underlying transactions remain the same.
| Current classification | After IFRS 18 amendments | |
| Cash generated from operations before interest | $140m | $140m |
| Interest paid within operating activities | ($30m) | — |
| Net cash from operating activities | $110m | $140m |
| Proceeds from borrowings | $100m | $100m |
| Repayment of borrowings | ($50m) | ($50m) |
| Interest paid within financing activities | — | ($30m) |
| Net cash from financing activities | $50m | $20m |
Operating cash flow rises by $30 million, or about 27 per cent. The combined net cash flow from operating and financing activities remains $160 million under either presentation. The company’s receipts, payments, borrowing and interest bill have not changed; only the location of the $30 million interest payment has moved.
Where interest moves under the new rules
IAS 7 currently permits several choices in the classification of interest and dividend cash flows. Interest paid can appear under operating or financing activities. Interest and dividends received can generally be classified as operating or investing, while dividends paid can sit within operating or financing activities. A company must apply its chosen policy consistently.
This flexibility means that two manufacturers with similar businesses and identical interest payments can report different operating cash flows, with the difference arising entirely from their accounting policies. The amendments accompanying IFRS 18 remove much of that discretion. For companies without “specified main business activities“, interest paid and dividends paid will be financing cash flows, while interest received and dividends received will be investing cash flows.
“Specified main business activities” is a defined concept under IFRS 18. It applies where investing in assets or providing financing to customers is a main business activity of the entity. Banks are the clearest example: interest sits much closer to their ordinary commercial activity than it does for a manufacturer or retailer, so different requirements apply.
For an ordinary non-financial business, the revised treatment puts the borrowing, repayment of principal and interest cost within the financing section. That gives the financing category a clearer economic logic and can produce a much larger operating cash-flow subtotal for companies that previously included substantial interest payments within operations.
The effect grows with borrowing costs
The size of the effect depends heavily on borrowing costs. Suppose another company generates $200 million in operating cash before interest and pays lenders $80 million. With the interest payment classified as operating, net operating cash flow is $120 million. Once the payment moves to financing, the figure becomes $200 million. That is a 67 per cent increase
Measures that use operating cash flow move with the subtotal: an operating cash-flow margin can improve sharply, while cash conversion ratios that use operating cash flow may look stronger. The effect can be especially pronounced for heavily borrowed companies, making the revised operating cash-flow figure look markedly stronger on those measures.
The higher figure has a valid interpretation because it shows more clearly how much cash the operating business produces before financing costs. For anyone assessing debt-servicing capacity, however, the analysis cannot stop at operating cash flow. The interest payment has moved into financing and remains a real claim on the company’s cash.
Comparing operating cash flow over time
IFRS 18 applies retrospectively. When a company first reports under the new standard, the comparative period presented alongside the current year will be restated, so the immediate year-on-year comparison should be on a consistent basis. Longer histories pose a different problem.
Older annual reports and financial databases may preserve operating cash flow as it was originally reported, and those figures may contain interest payments that newer figures exclude. Combining the two without adjustment can create an artificial improvement in the trend, particularly for companies with high borrowing costs. A five- or ten-year cash-flow series may therefore need more scrutiny than the chart suggests because the apparent improvement can come from a change in classification rather than a change in the business itself.
The new starting point for the indirect method
The amendments affect the indirect method as well. Companies currently use different profit measures as the starting point for reconciling profit to operating cash flow. From 2027, the reconciliation will begin with the IFRS 18 subtotal of operating profit or loss.
A common starting point should make the reconciliation more consistent and remove some adjustments for items already outside operating profit. The share of profit from associates and joint ventures accounted for using the equity method is one example.
This change affects the route used to reconcile profit to operating cash flow, while the classification change for interest has a different effect because it moves an actual cash payment between sections of the statement. Operating cash flow becomes more focused on the cash produced by the business itself, while financing captures more of the cash consequences of how that business is funded.
That division should make comparisons between similar companies easier, while placing more weight on reading the cash flow statement as a whole. A strong operating subtotal tells investors something useful about the underlying business; it says less about the cash left after lenders have been paid. For companies with substantial debt, that distinction may become more important once IFRS 18 takes effect.