Cash Flow Statement | ISC Class 12 Accounts Notes

This note covers the meaning, importance and objectives of a Cash Flow Statement, cash and cash equivalents under AS-3, the classification of operating, investing and financing activities, the indirect method of calculating cash flow from operating activities, the treatment of financing and investing items (shares, debentures, borrowings, fixed assets, investments, interest and dividend), the treatment of proposed dividend and provision for doubtful debts, and the preparation of a complete Cash Flow Statement for a manufacturing company.

What is a Cash Flow Statement and why is it prepared?

Meaning of a Cash Flow Statement

A Cash flow statement is a financial statement that shows inflows and outflows of cash and cash equivalents of an enterprise, classified under operating, investing and financing activities, over a particular accounting period.

It is prepared mainly by companies and acts as a tool for users of financial information to understand the sources and uses of cash over a period.

Along with the Balance Sheet (the position statement) and the Statement of Profit and Loss (the income statement), it forms the third major financial statement of a company.

Legal framework and objectives

Companies incorporated in India must prepare their financial statements following the accounting standards prescribed under the Companies Act, 2013.

Accounting Standards are notified under section 133 of this Act through the Accounting Standards Rules, 2006, and are mandatory in nature; if they are not followed, financial statements will not be regarded as true and fair.

Financial statements, as defined in section 2(40) of the Companies Act, 2013, include a Cash Flow Statement prepared in accordance with Accounting Standard-3 (AS-3), Cash Flow Statement.

The primary objective of a cash flow statement is to provide useful information about cash flows of an enterprise under operating, investing and financing activities, so that users can assess the enterprise's ability to generate cash and cash equivalents and its needs to utilise those cash flows.

Economic decisions taken by users require an evaluation of this ability together with the timing and certainty of cash generation.

In the ISC syllabus the statement is prepared only for manufacturing companies, which AS-3 treats as non-financial enterprises. That is why, in this unit, interest and dividend paid are always financing outflows and interest and dividend received are always investing inflows; a financial enterprise such as a bank would classify them differently.

What are cash and cash equivalents under AS-3?

Definition of cash and cash equivalents

Definition: Cash and cash equivalents. As per AS-3, "Cash" comprises cash in hand and demand deposits with banks. "Cash equivalents" means short-term highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.

An investment normally qualifies as a cash equivalent only when it has a short maturity, of say, three months or less from the date of acquisition.

Investments in shares are generally excluded from cash equivalents unless they are in substance cash equivalents, for example preference shares acquired shortly before their specified redemption date, provided there is only an insignificant risk of the company failing to repay the amount at maturity.

Short-term marketable securities that can be readily converted into cash, without considerable change in value, are also treated as cash equivalents.

For the purpose of the unit, the items taken as cash and cash equivalents are: cash, bank, short-term investments and marketable securities.

Cash flows, inflows and outflows

Cash flows are the movement of cash in and out of a business due to non-cash items.

A cash receipt from a non-cash item is a cash inflow while a cash payment in respect of such an item is a cash outflow.

Purchase of marketable securities or short-term investments that themselves constitute cash equivalents is not shown as a cash flow, because it is only a reshuffling of cash between two forms of the same resource.

How are activities classified for a cash flow statement?

The three categories of activities

As per AS-3, all cash flows are classified into three categories: operating activities, investing activities and financing activities, so that users can separately assess the impact of each on the financial position and on cash and cash equivalents.

A single transaction may fall into two heads

A single transaction may include cash flows classified differently. For example, in a deferred-payment instalment on a fixed asset the interest element is a financing activity while the loan (principal) element is an investing activity.

The same activity can also be classified differently for different enterprises, for example purchase of shares is an operating activity for a share-brokerage firm but an investing activity for most other enterprises.

Steps in preparing the statement

1. Identify the net profit before tax and extraordinary items as the starting figure.
2. Classify every item of the Balance Sheet and Statement of Profit and Loss into operating, investing or financing.
3. Adjust the starting figure for non-cash and non-operating items to arrive at operating profit before working capital changes.
4. Adjust for changes in current assets and current liabilities to arrive at cash generated from operations.
5. Deduct income tax paid and adjust for extraordinary items to arrive at net cash from operating activities.
6. List all investing inflows and outflows separately to arrive at net cash from investing activities.
7. List all financing inflows and outflows separately to arrive at net cash from financing activities.
8. Add the three net cash flows to the opening cash and cash equivalents to arrive at the closing balance, which must agree with the Balance Sheet figure.

What are the advantages of a Cash Flow Statement?

A cash flow statement, used along with the other financial statements, provides information that enables users to evaluate changes in the net assets of an enterprise, its financial structure (including liquidity and solvency), and its ability to affect the amount and timing of cash flows to adapt to changing circumstances and opportunities.

• Cash flow information helps users assess the ability of an enterprise to generate cash and cash equivalents and build models to assess and compare the present value of future cash flows of different enterprises.
• It enhances comparability of operating performance between enterprises by eliminating the effects of using different accounting treatments for the same transactions and events.
• It helps in balancing cash inflow and cash outflow in response to changing conditions.
• It helps in checking the accuracy of past assessments of future cash flows and in examining the relationship between profitability and net cash flow, and the impact of changing prices.

What are the limitations of a Cash Flow Statement?

A cash flow statement reports only cash transactions, so a company that is genuinely profitable in a period, but makes most of its sales on credit, can still show a weak cash position; the statement does not, by itself, measure overall profitability of the enterprise.

Being based on historical figures taken from the Balance Sheet and Statement of Profit and Loss, a cash flow statement does not predict future cash flows with certainty; it only explains how the cash position changed in the period already closed, and users must be careful before projecting the same pattern forward.

It also excludes non-cash investing and financing transactions, such as acquisition of machinery by issue of shares or redemption of debentures by issue of equity shares, because no cash or cash equivalents actually move. Such transactions must instead be disclosed elsewhere in the financial statements, so a reader relying only on the cash flow statement may miss an important change in the asset or capital structure of the enterprise.

A cash flow statement is also not a substitute for the Statement of Profit and Loss or the Balance Sheet; each of the three statements answers a different question (profitability, financial position, and liquidity respectively), so it supplements, rather than replaces, the other two, and all three must be read together for a complete picture of an enterprise.

How is cash flow from operating activities calculated by the Indirect Method?

Direct method and indirect method

As per AS-3, an enterprise may report cash flows from operating activities either by the Direct method, which discloses major classes of gross cash receipts and payments, or by the Indirect method, whereby net profit or loss is adjusted for (1) transactions of a non-cash nature, (2) deferrals or accruals of past or future operating cash receipts and payments, and (3) items of income or expense associated with investing or financing cash flows.

Under the indirect method the starting point is net profit before tax and extraordinary items, not the net profit as shown in the Statement of Profit and Loss.

The adjusted profit and loss account is not acceptable as per AS-3 for this calculation; the calculation of net profit before tax must be shown as a working note.

Adjustments under the indirect method

Non-cash items such as depreciation, goodwill written off, and provisions are added back, since they reduce profit without using cash.

Non-operating items are then treated according to their nature: expenses connected with financing or investing activities (such as finance cost) are added back, while incomes connected with financing or investing activities (such as interest received, dividend received or profit on sale of fixed assets) are deducted, because they will be shown separately under investing or financing activities.

Increase in current assets (other than cash and cash equivalents) and decrease in current liabilities are deducted from operating profit before working capital changes, while decrease in current assets and increase in current liabilities are added.

Worked examples

Worked example 1. A company's Statement of Profit and Loss shows Net Profit after Tax of ₹32,000 and Income Tax of ₹10,000. Depreciation charged was ₹20,000.

During the year, Trade Receivables increased by ₹3,000, Inventories increased by ₹5,000, Prepaid Insurance increased by ₹500, Trade Payables decreased by ₹2,000, and Outstanding Employees Benefits Expenses increased by ₹1,000. Income tax paid during the year was ₹11,000. Calculate the Net Cash from Operating Activities using the indirect method.

Answer: Net profit before taxation and extraordinary items = ₹32,000 + ₹10,000 = ₹42,000. Add depreciation ₹20,000 → operating profit before working capital changes = ₹62,000.

Less increase in trade receivables (₹3,000), less increase in inventories (₹5,000), less increase in prepaid insurance (₹500), less decrease in trade payables (₹2,000), plus increase in outstanding employees benefits expenses ₹1,000 → cash generated from operations = ₹52,500.

Less income tax paid (₹11,000) → Net cash from operating activities = ₹41,500.

Worked example 2. Anand Ltd. earned a net income of ₹5,00,000 for the year. Depreciation for the year was ₹2,00,000. There was a profit of ₹50,000 on assets sold, which was transferred to the Statement of Profit and Loss.

Trade Receivables increased during the year by ₹40,000 and Trade Payables also increased by ₹60,000. Compute the cash flow from operating activities by the indirect approach.

Answer: Net income ₹5,00,000, plus depreciation ₹2,00,000 = ₹7,00,000. Less profit on sale of assets (₹50,000), since it is a non-operating investing inflow = ₹6,50,000. Less increase in trade receivables (₹40,000) = ₹6,10,000. Plus increase in trade payables ₹60,000 = ₹6,70,000. Net cash from operating activities = ₹6,70,000.

How are items of investing activities treated?

Meaning and items of investing activities

Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents, for example machinery, furniture, land and building, and long-term investments.

Separate disclosure of cash flows from investing activities is important because they show the extent to which expenditure has been made for resources intended to generate future income and cash flows.

For this unit, the items taken when calculating net cash flow from investing activities are: cash purchase and cash sale of Property, Plant and Equipment and intangible assets; purchase and proceeds from sale of shares, debentures or long-term investments of other companies; loans and advances given (short-term or long-term) and their repayment; and interest and dividend received on shares, debentures or long-term investments of other companies, and interest received on loans and advances given.

Worked example

Worked example 3. Welprint Ltd. had Machinery of ₹50,000 on 1 April 2016 and ₹60,000 on 31 March 2017. Accumulated Depreciation was ₹25,000 on 1 April 2016 and ₹15,000 on 31 March 2017.

During the year, a machine costing ₹25,000 with accumulated depreciation of ₹15,000 was sold for ₹13,000. Calculate the cash flow from investing activities.

Answer: Sale of machinery = ₹13,000 (inflow). By preparing the Machinery and Accumulated Depreciation accounts as working notes, the balancing figure for new machinery purchased during the year works out to ₹35,000 (outflow).

Net cash flows from investing activities = ₹13,000 − ₹35,000 = ₹(22,000), that is, net cash used in investing activities of ₹22,000.

How is a profit or loss on the sale of investments treated?

The whole sale price of investments is an investing inflow. Any profit on the sale is deducted from net profit under operating activities, and any loss added back, because it is not an operating gain and the cash is already shown in full under investing activities.

For example, investments costing ₹20,000 sold for ₹26,000 give an investing inflow of ₹26,000 and a deduction of ₹6,000 in the operating section.

How are items of financing activities treated?

Meaning and items of financing activities

Financing activities relate to long-term funds or capital of an enterprise and are activities that result in changes in the size and composition of the owners' capital (including preference share capital) and borrowings.

For this unit, the items taken when calculating net cash flow from financing activities are: issue of shares at par and at premium; issue of debentures at par, premium and discount; redemption of preference shares and debentures at par; interest paid on long-term and short-term borrowings; dividend, both interim and final, paid on shares; long-term and short-term borrowings, including bank overdraft, cash credit and short-term loan, whether taken or repaid; and share issue expenses or underwriting commission paid.

Worked example

Worked example 4. A company's Long-term Loans stood at ₹2,00,000 on 1 April and ₹2,50,000 on 31 March. During the year, the company repaid a loan of ₹1,00,000. Calculate the cash flow from financing activities.

Answer: From the Long-term Loan account, the loan repaid (outflow) of ₹1,00,000 is given. The balancing figure for new loan raised during the year (inflow) works out to ₹1,50,000.

Net cash flows from financing activities = Proceeds from long-term borrowings ₹1,50,000 − Repayment of long-term borrowings ₹1,00,000 = Net cash inflow from financing activities of ₹50,000.

Classifying interest, dividend and tax

Where a non-financial enterprise is concerned, as per AS-3, payment of interest and dividends is classified as financing activities, whereas receipt of interest and dividends is classified as investing activities.

Taxes on income should be classified as operating cash flows unless they can be specifically identified with financing or investing activities; for example, dividend tax paid is classified along with dividend paid under financing activities, while capital gains tax paid on sale of fixed assets is classified under investing activities.

How is an interim dividend treated?

An interim dividend is declared and paid during the year, so it is a financing outflow of the year in which it is paid. When net profit has to be worked out from the change in the surplus, the interim dividend paid out of that surplus is added back, along with the tax provided for the year, to reach the net profit before tax.

How are the uses of Securities Premium treated?

Under Section 52 of the Companies Act, 2013, Securities Premium may be used only for issuing fully paid bonus shares, writing off preliminary expenses, writing off the expenses of, commission paid on or discount allowed on an issue of shares or debentures, providing for the premium payable on redemption of preference shares or debentures, and buying back the company's own shares.

The premium received in cash when shares or debentures are issued is a financing inflow, shown together with the face value. Its later use for these purposes is a book entry with no cash, so it does not appear in the statement; only cash actually paid, for example on a buy-back or a redemption, appears under financing activities.

How is proposed dividend treated in the Cash Flow Statement?

The rule for proposed dividend

Note: Treatment of proposed dividend. Dividend proposed for the previous year will be an outflow of cash, unless otherwise stated, on the assumption that the proposed amount has been approved by the shareholders in the Annual General Meeting.

No effect is given to proposed dividend for the current year, as it is not provided for and remains a contingent liability.

Any unpaid dividend is transferred to the Dividend Payable Account, shown in the Balance Sheet as Other Current Liabilities.

As per AS-4, proposed dividend is shown in the Notes to Accounts as a contingent liability, since it becomes an actual liability only after being declared by the shareholders.

Why the previous year's figure is treated as paid

Because declared dividend is normally paid within 30 days of declaration, the previous year's proposed dividend is treated as being declared and paid within the current financial year.

While preparing the cash flow statement, the previous year's proposed dividend amount is added back to net profit under operating activities (treating it as a non-operating appropriation of profit) and the same amount is shown as an outflow under financing activities.

How is provision for doubtful debts treated?

The two acceptable treatments

Provision for doubtful debts can be treated either as a charge against profits or as part of the working capital changes. Where debtors are good, the provision is instead treated as an appropriation of profit.

When the provision is treated as a charge against profit, it behaves like depreciation: the increase in the provision during the year is added back to net profit under non-cash items, in the same step as depreciation and goodwill written off, before arriving at operating profit before working capital changes.

Avoiding a double adjustment

In practice, if the provision is added back as a non-cash charge under operating profit before working capital changes, the full (gross) figure of trade receivables, before deducting the provision, should then be used when computing the increase or decrease in trade receivables for the working capital adjustment, so that the same amount is not adjusted twice.

Alternatively, if the provision is treated as part of the working capital change itself, the net figure of trade receivables (after deducting the provision) is used directly for the working capital adjustment, and no separate add-back of the provision is made among the non-cash items. Either treatment, applied consistently, arrives at the same net cash from operating activities.

How is a complete Cash Flow Statement prepared?

Format of the complete statement

A cash flow statement shows, under each of the three headings, full details of inflows and outflows, and the net cash flow (or use) for that activity.

The three net cash flows are aggregated and shown as the net increase or decrease in cash and cash equivalents, to which the cash and cash equivalents at the beginning of the period is added to arrive at the cash and cash equivalents at the end, which must agree with the figure for cash and bank balances (and any cash equivalents) shown in the Balance Sheet.

Exclusions and formulas

Unless an extraordinary item or an item relating to refund of tax is specifically stated, such adjustments are not required for this unit. Any transaction pertaining to Capital Reserve is also excluded from the preparation.

Net increase in cash = CFO + CFI + CFF

Closing cash = Opening cash + Net increase

NPBT = PAT + Tax provision (when net profit after tax and tax provision for the year are given directly; when deriving profit from two years' Balance Sheets, also add back transfer to reserve and proposed dividend charged against the year's surplus)

Cash equivalents = Cash + Bank + short-term investments + marketable securities

Worked example: a complete statement from two Balance Sheets

Worked example 5. Rohini Manufacturing Ltd. shows these Balance Sheets (₹) on 31 March 2025 and 31 March 2026. Equity and liabilities: Equity share capital 4,00,000 and 5,00,000; Securities Premium nil and 10,000; Surplus (Statement of Profit and Loss) 60,000 and 1,10,000; 10% Debentures 1,00,000 and 60,000; Trade payables 40,000 and 55,000; Provision for tax 20,000 and 25,000 (totals 6,20,000 and 7,60,000). Assets: Machinery (net) 3,50,000 and 4,30,000; Non-current investments 50,000 and 30,000; Inventories 70,000 and 90,000; Trade receivables 80,000 and 1,00,000; Cash and cash equivalents 70,000 and 1,10,000 (totals 6,20,000 and 7,60,000).

Additional information: depreciation on machinery for the year was ₹40,000, and a machine with a book value of ₹30,000 was sold for ₹25,000; investments costing ₹20,000 were sold for ₹26,000; tax of ₹25,000 was provided for the year; an interim dividend of ₹30,000 was paid; debentures of ₹40,000 were redeemed at par on 1 April 2025 and the year's interest on the rest was paid; the new shares were issued at a premium of 10%. Prepare the Cash Flow Statement.

Answer: Net cash from operating activities ₹1,05,000; net cash used in investing activities ₹99,000; net cash from financing activities ₹34,000. The net increase of ₹40,000, added to the opening ₹70,000, gives ₹1,10,000, the closing balance in the Balance Sheet.

Working note 1: net profit before tax = increase in surplus ₹50,000 (₹1,10,000 less ₹60,000) + interim dividend ₹30,000 + tax provided ₹25,000 = ₹1,05,000.

Working note 2: tax paid = opening provision ₹20,000 + tax provided ₹25,000 less closing provision ₹25,000 = ₹20,000.

Working note 3: machinery purchased = closing ₹4,30,000 + depreciation ₹40,000 + book value of the machine sold ₹30,000 less opening ₹3,50,000 = ₹1,50,000.

Going beyond the syllabus

In practice, most listed companies, including Indian companies required by the Companies Act, 2013 to prepare a cash flow statement under AS-3, use the indirect method rather than the direct method. The direct method is more informative for forecasting future cash flows because it discloses gross receipts and payments head by head, but it requires maintaining detailed cash-receipt and cash-payment records for every head of income and expense, which is considerably more laborious for a large manufacturing company to maintain.

A reader comparing two years of cash flow statements for the same enterprise can see whether rising reported profit is matched by rising cash from operations; a persistent gap between the two, where profit keeps rising but operating cash flow stays flat or falls, is often an early warning sign of mounting trade receivables or inventories, and is worth investigating further before relying on the reported profit figure alone.

The horizontal axis shows successive accounting years and the vertical axis shows amount in ₹; one line plots net profit after tax for each year and a second line plots net cash from operating activities for the same years. When the two lines move together, reported profit is being converted into cash; when the net-profit line keeps rising while the cash-from-operations line flattens, it signals that profit is increasingly tied up in receivables or inventories rather than being collected as cash.

The horizontal axis lists the three heads, operating, investing and financing activities, and the vertical axis shows the net cash flow (inflow or outflow) in ₹ for each head, drawn as a bar above or below the zero line. A company funding new fixed assets (an investing outflow) from cash generated by operations (an operating inflow), while repaying borrowings (a financing outflow), shows a pattern of a tall positive operating bar balanced against negative investing and financing bars, which is typically read as a financially healthy enterprise.

The worked examples above, such as Anand Ltd. and Welprint Ltd., are Indian companies of the kind that must prepare a cash flow statement in this format under the Companies Act, 2013, as part of their annual financial statements presented to shareholders at the Annual General Meeting.

Glossary

• Cash flow statement: a statement showing inflows and outflows of cash and cash equivalents classified into operating, investing and financing activities for a period.
• Cash equivalents: short-term, highly liquid investments readily convertible into known amounts of cash, with insignificant risk of change in value, normally maturing within three months.
• Operating activities: the principal revenue-generating activities of an enterprise that are not investing or financing activities.
• Investing activities: acquisition and disposal of long-term assets and other investments not included in cash equivalents.
• Financing activities: activities that change the size and composition of owners' capital and borrowings of the enterprise.
• Indirect method: a method of calculating cash flow from operating activities by adjusting net profit for non-cash, non-operating items and working capital changes.
• Direct method: a method of calculating cash flow from operating activities by disclosing major classes of gross cash receipts and payments.
• Net profit before tax and extraordinary items: the starting figure for the indirect method, found by adding back provision for tax (and adjusting for extraordinary items) to net profit after tax.
• Non-cash items: items such as depreciation and goodwill written off that reduce profit without any movement of cash.
• Working capital changes: increases or decreases in current assets and current liabilities during the year that must be adjusted to convert profit into cash from operations.
• Proposed dividend: dividend recommended by directors but not yet approved by shareholders; a contingent liability until declared at the Annual General Meeting.
• Extraordinary items: non-recurring gains or losses, such as loss due to theft, earthquake or flood, disclosed separately from ordinary activities.
• AS-3: Accounting Standard-3, "Cash Flow Statement", which prescribes the classification and preparation of the cash flow statement.
• Cash inflow: a receipt of cash arising from a non-cash transaction, such as sale proceeds of machinery.
• Cash outflow: a payment of cash arising from a non-cash transaction, such as purchase of machinery.

Common errors and misconceptions

• Misconception: The starting point for the indirect method is the net profit after tax shown in the Statement of Profit and Loss. Correct: The starting point is net profit before tax and extraordinary items; income tax paid is deducted later, as the last item before arriving at net cash from operating activities.
• Misconception: Purchase of marketable securities is a cash outflow in the cash flow statement. Correct: Since marketable securities are themselves cash equivalents, such a purchase is not shown as a cash flow at all.
• Misconception: Proposed dividend for the current year is deducted as an outflow in the current year's statement. Correct: No effect is given to the current year's proposed dividend, as it is only a contingent liability; it is the previous year's proposed dividend that is treated as paid in the current year.
• Misconception: Depreciation is deducted again when calculating cash from operations, because it was already deducted in the Statement of Profit and Loss. Correct: Depreciation is a non-cash charge, so it is added back to net profit, not deducted again.
• Misconception: Interest received and interest paid are always classified the same way. Correct: For a non-financial enterprise, interest paid and dividends paid are financing activities while interest received and dividends received are investing activities; for a financial enterprise, interest paid, interest received and dividend received are operating activities.
• Misconception: Acquisition of an asset by issuing shares is shown as both an investing outflow and a financing inflow. Correct: Since no cash or cash equivalents are involved, this non-cash transaction is excluded from the cash flow statement altogether and disclosed elsewhere.
• Misconception: An increase in trade receivables is added to operating profit before working capital changes. Correct: An increase in trade receivables (a current asset) is deducted, since it means less cash was actually collected than the revenue recognised.

Exam-style questions with model answers

Q1. State the three heads under which cash flows are classified as per AS-3. [1 mark]

1. Operating, investing and financing activities.

Q2. A company shows Provision for Taxation of ₹10,000 at the start of the year and ₹13,000 at the end of the year, and tax paid during the year was ₹5,000 (debited to the Provision for Taxation account). State how the ₹5,000 income tax paid is shown while preparing the cash flow statement by the indirect method. [2 marks]

1. Income tax paid of ₹5,000 is deducted from "Cash generated from operations" under operating activities.
2. It is the last deduction made before arriving at the figure of net cash from operating activities.

Q3. Distinguish between operating activities and investing activities, with one example of each from a manufacturing company. [3 marks]

1. Operating activities are the principal revenue-generating activities of the enterprise, for example cash receipts from sale of goods, while investing activities relate to acquisition and disposal of long-term assets, for example cash purchase of machinery.
2. Operating activities generally result from transactions entering into the determination of net profit or loss, whereas investing activities relate to resources intended to generate future income.
3. Cash flows from operating activities indicate the internal solvency of the enterprise, while cash flows from investing activities show the extent of expenditure on long-term resources.

Q4. A company's Net Profit before Tax and Extraordinary Items was ₹20,000. During the year, Depreciation of ₹5,000 and Goodwill Amortised of ₹2,000 were charged, and there was a Loss on Sale of Equipment of ₹3,000, which was included in expenses. Other Income included a Profit on Sale of Machinery of ₹2,000. Calculate the operating profit before working capital changes. [4 marks]

1. Start with Net Profit before Tax and Extraordinary Items of ₹20,000.
2. Add back Depreciation ₹5,000 (non-cash item).
3. Add back Goodwill Amortised ₹2,000 and Loss on Sale of Equipment ₹3,000 (non-cash/non-operating items), giving ₹30,000.
4. Deduct Profit on Sale of Machinery ₹2,000 (non-operating investing income), giving Operating Profit before Working Capital Changes of ₹28,000.

Q5. Welprint Ltd. had Machinery of ₹50,000 on 1 April 2016, rising to ₹60,000 on 31 March 2017. Accumulated Depreciation fell from ₹25,000 to ₹15,000 over the year. During the year, a machine costing ₹25,000, with accumulated depreciation of ₹15,000, was sold for ₹13,000. Calculate the cash flow from investing activities. [5 marks]

1. Sale proceeds of machinery received = ₹13,000, a cash inflow from investing activities.
2. The machine sold had a cost of ₹25,000 and accumulated depreciation of ₹15,000, so its book value was ₹10,000; sold for ₹13,000, this gives a profit on sale of ₹3,000.
3. Machinery account (at cost): opening balance ₹50,000, less the cost of the machine sold ₹25,000, plus new machinery purchased (the balancing figure), equals the closing balance of ₹60,000. The Accumulated Depreciation account is worked separately and gives the year's depreciation; it does not change the cash spent on machinery.
4. The balancing figure, representing new machinery purchased during the year, works out to ₹35,000, a cash outflow from investing activities.
5. Net cash flows from investing activities = ₹13,000 (inflow) − ₹35,000 (outflow) = Net cash used in investing activities of ₹22,000.

Q6. Anand Ltd. earned a net income of ₹5,00,000 for the year ended 31 March. Depreciation for the year was ₹2,00,000. There was a profit of ₹50,000 on assets sold, transferred to the Statement of Profit and Loss. Trade Receivables increased by ₹40,000 and Trade Payables increased by ₹60,000 during the year. Compute the cash flow from operating activities by the indirect approach. [6 marks]

1. Start with the net income of ₹5,00,000, which is the base figure for the indirect method.
2. Add back Depreciation of ₹2,00,000, since it is a non-cash charge, giving ₹7,00,000.
3. Deduct the Profit on sale of assets of ₹50,000, since this is a non-operating investing inflow that will be shown separately under investing activities, giving ₹6,50,000; this is the operating profit before working capital changes.
4. Adjust for the increase in Trade Receivables of ₹40,000 (a current asset increase), which is deducted since it means less cash was actually received than revenue recognised, giving ₹6,10,000.
5. Adjust for the increase in Trade Payables of ₹60,000 (a current liability increase), which is added since payment to suppliers has effectively been deferred, giving ₹6,70,000.
6. Net cash flow from operating activities = ₹6,70,000.

Q7. State the treatment of proposed dividend for the previous year and for the current year while preparing a cash flow statement. [4 marks]

1. Proposed dividend for the previous year is treated as a cash outflow, on the assumption that it has been approved by the shareholders in the Annual General Meeting of the current year.
2. This amount is added back to net profit under operating activities, since it was an appropriation rather than a true operating charge.
3. The same amount is shown as an outflow under financing activities, since dividend paid is a financing cash flow.
4. No effect is given to the proposed dividend of the current year, as it has not yet been approved and remains only a contingent liability disclosed in the Notes to Accounts.

Key takeaways

• A cash flow statement is prepared under AS-3 and classifies cash flows into operating, investing and financing activities for a period.
• Cash comprises cash in hand and demand deposits with banks; cash equivalents are short-term, highly liquid investments maturing within about three months.
• Under the indirect method, the starting figure is net profit before tax and extraordinary items, not net profit as shown in the Statement of Profit and Loss.
• Non-cash items such as depreciation and goodwill written off are added back to profit; non-operating financing expenses are added back and non-operating investing incomes are deducted.
• Increase in current assets and decrease in current liabilities are deducted from operating profit before working capital changes; decrease in current assets and increase in current liabilities are added.
• Income tax paid is deducted as the last item under operating activities to arrive at net cash from operating activities.
• Previous year's proposed dividend is treated as an outflow under financing activities; current year's proposed dividend has no effect, being only a contingent liability.
• Non-cash investing and financing transactions, such as acquiring assets by issue of shares, are excluded from the cash flow statement.
• The net increase or decrease in cash and cash equivalents, added to the opening balance, must equal the closing cash and cash equivalents shown in the Balance Sheet.

Test yourself

Which method of calculating cash flow from operating activities does AS-3 recognise, apart from the indirect method?

The direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed separately.

Is purchase of goodwill classified as an operating, investing or financing activity?

It is an investing activity, since goodwill is a long-term intangible asset not included in cash equivalents.

How is dividend received treated for a non-financial enterprise?

It is classified as an investing activity, since the dividend arises from investments rather than from the main operating activity.

What happens to an increase in prepaid expenses when calculating cash from operating activities?

It is deducted from operating profit before working capital changes, since more cash was paid in advance than was charged as an expense.

Why is the adjusted profit and loss account not acceptable for calculating cash from operating activities under AS-3?

Because AS-3 requires the calculation to begin from net profit before tax and extraordinary items, with the working shown separately, not from a combined adjusted account.

How is interest paid on long-term borrowings treated for a non-financial enterprise?

It is added back to net profit under operating activities (since it was deducted there) and then shown as an outflow under financing activities.

What is excluded from the cash flow statement under this unit relating to reserves?

Any transaction pertaining to Capital Reserve is excluded.

How does an increase in a bank overdraft affect the cash flow statement?

A bank overdraft is treated as a short-term borrowing; an increase in it is a cash inflow shown under financing activities.