Cash Flow Statement — Notes

A cash flow statement reports the cash inflows and outflows of an enterprise for a period, grouped as operating, investing and financing activities, and ends by reconciling opening and closing cash and cash equivalents. It is governed by Accounting Standard 3 (Cash Flow Statements). Under the Companies Act, 2013 it forms part of the financial statements of a company (a one person company, a small company and a dormant company may omit it).

Why profit and cash differ: profit is measured on the accrual basis (credit sales, unpaid expenses, depreciation), whereas cash changes only when money is received or paid; buying assets and repaying loans use cash without touching profit.

Objectives:

• to report where cash came from and where it went, by activity;
• to judge whether the main business generates enough cash to pay its way, and to judge liquidity;
• to explain the difference between profit and the change in cash;
• to help plan future cash requirements, repayments and dividends;
• to compare years and enterprises on a basis little affected by accounting policies.

• Cash: cash on hand and demand deposits with banks.
• Cash equivalents: short-term, highly liquid investments that are readily convertible into known amounts of cash and subject to an insignificant risk of change in value. An investment normally qualifies only when it has a short maturity of three months or less from the date of acquisition (for example, treasury bills, commercial paper, short bank deposits, overnight money-market funds). Equity shares are excluded; preference shares bought shortly before a fixed redemption date may qualify.
• Cash flows: inflows and outflows of cash and cash equivalents.

Not cash flows:

• movements between items of cash and cash equivalents (buying a 60-day treasury bill from the bank balance), because the total does not change;
• non-cash investing and financing transactions (assets acquired by issuing shares, bonus shares, conversion of one security into another); they are excluded from the statement and disclosed elsewhere.

Operating activities — the principal revenue-producing activities of the enterprise and other activities that are not investing or financing. Examples: cash from sale of goods and services, royalties, fees and commission; payments to suppliers and employees; income tax paid (unless specifically identified with investing or financing).

Investing activities — the acquisition and disposal of long-term assets and of investments not included in cash equivalents. Examples: purchase and sale of land, buildings, machinery, vehicles, patents and goodwill; purchase and sale of shares and debentures of other enterprises; loans and advances made to others (by a non-financial enterprise) and their recovery.

Financing activities — activities that change the size and composition of owners’ capital and borrowings. Examples: issue of shares and debentures; raising and repaying loans; payment of dividends and of interest (non-financial enterprise).

Interest and dividends are classified according to the nature of the enterprise:

• Non-financial enterprise (manufacturer, trader): interest and dividend received → investing; interest and dividend paid → financing.
• Financial enterprise (bank, lending company): interest paid, interest received and dividend received → operating, since lending is its principal business; dividend paid → financing.

Income tax paid is operating unless it can be specifically identified with an investing or financing activity.

Short-term borrowings (bank loan, cash credit) are treated in this chapter as financing activities.

A classification answer should name the activity and show whether the item is an inflow or an outflow; totals are then worked activity by activity (worked example 2).

Accounting Standard 3 permits the direct method (gross receipts and payments) and the indirect method for operating activities; the CBSE syllabus uses only the indirect method. Investing and financing sections are prepared in the same way under both.

Step 1 — net profit before tax. The balance sheet shows only the retained part of profit, so rebuild it:

Net profit before tax = (closing − opening surplus) + transfers to reserves + dividends paid during the year (final for the previous year and interim) + provision for tax made during the year.

If tax is paid and charged without a provision, add the tax charged instead. Extraordinary items are not in the 2026-27 syllabus, so the first line is simply "net profit before tax".

Step 2 — non-cash and non-operating items.

• Add: depreciation and amortisation; goodwill, patents and other intangibles written off; loss on sale of fixed assets or investments; interest and other finance costs.
• Deduct: profit on sale of fixed assets or investments; interest received and dividend received (non-financial enterprise).
• The result is operating profit before working capital changes.

Step 3 — working capital. For each current asset (inventories, trade receivables including bills receivable, prepaid expenses): increase → deduct, decrease → add. For each current liability (trade payables including bills payable, outstanding expenses): increase → add, decrease → deduct. The result is cash generated from operations. Cash and cash equivalents, provision for tax and short-term borrowings are not part of this step.

Step 4 — tax. Deduct income tax paid, found from the provision for tax account (opening + provision for the year − closing). The result is net cash from operating activities.

Working accounts find the figures the balance sheets hide:

• Asset account at cost (with a separate accumulated depreciation account): the asset sold leaves at cost against its accumulated depreciation, the sale price and the profit or loss; purchases are the balancing figure.
• Accumulated depreciation account: opening + depreciation for the year − depreciation on the asset sold = closing; the depreciation for the year is usually the balancing figure.
• Asset at written-down value: opening + purchases + profit on sale = sale price + loss on sale + depreciation + closing.
• Investments account: opening + purchases + profit on sale = sale price + loss on sale + closing.

Investing: purchases (outflows) and full sale prices (inflows) of fixed assets, intangibles and investments; interest and dividend received.

Financing: proceeds of shares (including premium; excluding shares issued to vendors or as bonus) and of debentures and loans; repayments; interest paid (work it on the balance and period outstanding); dividends paid.

The cash check: net increase or decrease (A + B + C) + opening cash and cash equivalents = closing cash and cash equivalents. Each balance sheet line must be explained by exactly one entry.