AccountancyCash flow statement (indirect method), solved
A company can show a profit and still run out of cash. The cash flow statement shows where cash actually came from and where it went.
What it is
A cash flow statement shows the inflows and outflows of cash and cash equivalents during a period, classified under three activities. It is prepared according to Accounting Standard 3 (Revised). Cash means cash in hand and demand deposits with banks. Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash, such as treasury bills and short-term deposits, normally with a maturity of three months or less.
The three activities
| Activity | Meaning | Examples |
|---|---|---|
| Operating | The main revenue-producing activities of the business | Cash from customers; cash paid to suppliers and employees; income tax paid |
| Investing | Buying and selling long-term assets and investments not included in cash equivalents | Purchase or sale of machinery, land, investments; interest and dividend received (for a non-finance company) |
| Financing | Changes in owners' capital and borrowings | Issue of shares or debentures; repayment of loans; interest and dividend paid |
For a finance company, interest paid and interest and dividend received are operating items, because lending and investing are its main business. Transactions that involve no cash, such as issuing shares to buy machinery, are left out of the statement.
Cash from operating activities: the indirect method
Start from net profit and remove everything in it that is not an operating cash flow.
| Particulars | ||
|---|---|---|
| Net profit before tax and extraordinary items | ||
| Add: Non-cash and non-operating expenses: depreciation, goodwill written off, loss on sale of assets, interest paid | ||
| Less: Non-operating incomes: profit on sale of assets, interest and dividend received | ||
| Operating profit before working capital changes | ||
| Add: Decrease in current assets; increase in current liabilities | ||
| Less: Increase in current assets; decrease in current liabilities | ||
| Cash generated from operations | ||
| Less: Income tax paid | ||
| Net cash from operating activities |
Why working capital changes matter: if debtors rise by ₹15,000, that much of the year's sales has not yet turned into cash, so it is deducted. If creditors rise by ₹15,000, that much of the purchases has not yet been paid for, so it is added.
Net profit before tax
The balance sheets give only the change in surplus. Work backwards: Net profit before tax = Increase in surplus (balance of Statement of Profit and Loss) + Dividend paid + Transfer to reserves + Provision for tax made during the year.
Solved example
From the balance sheets of Godavari Ltd., prepare a cash flow statement for the year ended 31 March 2026.
| Particulars | 31 March 2025 | 31 March 2026 |
|---|---|---|
| Share capital | 4,00,000 | 5,00,000 |
| Surplus (balance of Statement of Profit and Loss) | 1,00,000 | 1,60,000 |
| 10% Debentures | 2,00,000 | 1,50,000 |
| Trade payables | 80,000 | 95,000 |
| Total equity and liabilities | 7,80,000 | 9,05,000 |
| Particulars | 31 March 2025 | 31 March 2026 |
|---|---|---|
| Plant and machinery (net) | 4,00,000 | 4,80,000 |
| Inventories | 1,50,000 | 1,70,000 |
| Trade receivables | 1,20,000 | 1,35,000 |
| Cash and cash equivalents | 1,10,000 | 1,20,000 |
| Total assets | 7,80,000 | 9,05,000 |
Additional information: (1) Depreciation of ₹50,000 was charged on plant and machinery; no machinery was sold. (2) Debentures of ₹50,000 were redeemed on 1 October 2025. (3) A dividend of ₹40,000 was paid during the year. Ignore tax.
Working notes
- Net profit before tax = increase in surplus ₹60,000 + dividend paid ₹40,000 = ₹1,00,000.
- Machinery purchased = closing ₹4,80,000 + depreciation ₹50,000 − opening ₹4,00,000 = ₹1,30,000.
- Interest on debentures = ₹2,00,000 × 10% × 6/12 + ₹1,50,000 × 10% × 6/12 = ₹10,000 + ₹7,500 = ₹17,500.
| Date | Particulars | ₹ | Date | Particulars | ₹ |
|---|---|---|---|---|---|
| To Balance b/d | 4,00,000 | By Depreciation A/c | 50,000 | ||
| To Bank A/c (purchase, balancing figure) | 1,30,000 | By Balance c/d | 4,80,000 | ||
| 5,30,000 | 5,30,000 |
| Particulars | ₹ | ₹ |
|---|---|---|
| A. Cash flow from operating activities | ||
| Net profit before tax | 1,00,000 | |
| Add: Depreciation | 50,000 | |
| Interest on debentures | 17,500 | 67,500 |
| Operating profit before working capital changes | 1,67,500 | |
| Add: Increase in trade payables | 15,000 | |
| Less: Increase in inventories | (20,000) | |
| Less: Increase in trade receivables | (15,000) | (20,000) |
| Net cash from operating activities | 1,47,500 | |
| B. Cash flow from investing activities | ||
| Purchase of plant and machinery | (1,30,000) | |
| Net cash used in investing activities | (1,30,000) | |
| C. Cash flow from financing activities | ||
| Issue of share capital | 1,00,000 | |
| Redemption of debentures | (50,000) | |
| Interest paid on debentures | (17,500) | |
| Dividend paid | (40,000) | |
| Net cash used in financing activities | (7,500) | |
| Net increase in cash and cash equivalents (A + B + C) | 10,000 | |
| Add: Cash and cash equivalents at the beginning | 1,10,000 | |
| Cash and cash equivalents at the end | 1,20,000 |
Figures in brackets are outflows. The closing figure, ₹1,20,000, agrees with the balance sheet, which proves the statement.
What the statement tells us
Godavari Ltd. generated ₹1,47,500 from its operations. That was enough to pay for new machinery of ₹1,30,000 and most of the interest and dividend. It raised ₹1,00,000 from shareholders and used half of it to repay debentures. This is a healthy pattern: operations paying for growth, and borrowing coming down.
Treatment of special items
- Provision for tax: the opening provision is treated as paid during the year (operating outflow) and the closing provision as made during the year (added back to find profit before tax), unless other information is given.
- Sale of a fixed asset: the sale proceeds are an investing inflow. The profit or loss on sale is removed from operating profit.
- Bank overdraft and cash credit: treated as short-term borrowings; changes are financing activities.
- Current investments and marketable securities are cash equivalents if they meet the definition.
- Goodwill or patents written off: added back like depreciation.
Uses and limits
- Shows the ability to generate cash and to pay dividends and debts.
- Explains why cash rose or fell although profit moved the other way.
- Helps in short-term planning.
- Limits: it ignores non-cash transactions and the accrual concept, so it cannot replace the Statement of Profit and Loss; and it shows the past, not the future.
Questions students ask
Is depreciation a source of cash?
No. It is added back to net profit because it reduced profit without any cash going out. It does not bring cash in.
Under which activity is interest paid shown?
For a non-finance company, interest paid on borrowings is a financing activity, and interest received is an investing activity. For a finance company both are operating activities.
How do I check a cash flow statement?
The net increase or decrease, added to the opening cash and cash equivalents, must equal the closing cash and cash equivalents in the balance sheet.
More Class 12 topics
For study, and independent. These pages explain accountancy as it is generally taught in Class 11, Class 12 and B.Com courses in India, in our own words with our own examples, reviewed in November 2026. This site is not connected with NCERT, CBSE, ICAI or any board or university. Syllabuses change: follow your own board's or university's current syllabus and textbook. Nothing here is professional accounting, tax or legal advice.