Advanced Accounting · AS 3 Cash Flow Statement

Preparing a Cash Flow Statement: Comprehensive Problems (AS 3)

Updated 4 October 2026 · Fact-checked

A cash flow statement under AS 3 shows how cash and cash equivalents changed during the year, split into operating, investing and financing activities. To solve a problem, find profit before tax, adjust for non-cash and non-operating items, adjust working capital, then derive each flow from balance sheet changes and tie the total to the cash movement.

Understand Preparing a Cash Flow Statement: Comprehensive Problems

A cash flow statement explains why cash went up or down between two balance sheet dates. Profit is not cash. A company can show profit and still run short of cash, because of credit sales, stock build-up or loan repayments. AS 3 makes you show cash movements in three groups.

Operating activities are the main revenue-producing activities of the business. Investing activities are buying and selling long-term assets and investments not counted as cash equivalents. Financing activities change the size and make-up of owners' capital and borrowings.

The statement explains movement in cash and cash equivalents. These are cash in hand, demand deposits, and short-term, highly liquid investments that convert readily into known amounts of cash with insignificant risk of change in value. A common test is an original maturity of three months or less from the date of acquisition. A fixed deposit that had a longer maturity when made is not a cash equivalent.

A comprehensive problem gives you two balance sheets and some additional information. Treat each balance sheet change as a clue. A rise in a non-cash asset uses cash. A rise in a liability or capital item brings cash in. Then pull out the items that are non-cash (depreciation, transfers to reserves) or belong to another section (interest, dividends, profit on sale of assets).

For financial enterprises (banks, finance companies) the classification differs. Interest paid, interest received and dividends received are normally operating. Deposits accepted and repaid and loans and advances to customers are also operating. For other enterprises, interest and dividends received are investing, and interest and dividends paid are financing, applied consistently from period to period. Income-tax cash flows are operating unless you can tie them specifically to an investing or financing activity.

Key rules to remember

Net change in cash: Net increase/(decrease) = Operating CF + Investing CF + Financing CF; Add or subtract the effect of exchange rate changes on foreign currency cash separately, if given. Then: Closing cash and cash equivalents = Opening + Net increase/(decrease).
Indirect method start: Net profit before tax = Closing P&L balance − Opening P&L balance + Transfers to reserves + Dividend paid/proposed charged to P&L balance + Tax charge for the year; Use this when the P&L account is not given and you only have balance sheets. The result is net profit before tax and extraordinary items only when any extraordinary items are separately added back. Transfers to reserves equal the change in reserves only if there are no other reserve movements (such as utilisation of a reserve, bonus issue out of reserves or a capital reserve created otherwise). Adjust if the question gives different appropriations.
Cash from operations: Cash generated from operations = Profit before tax + Depreciation + Interest expense − Interest/dividend income − Profit on sale of assets (add back losses) ± Changes in working capital; For non-financial companies, remove interest and dividend items from operating and show them in financing or investing. For financial enterprises, do not remove them. For financial enterprises, loans and advances to customers and deposits accepted are operating items, so include their changes in the working capital adjustment.
Working capital changes: Increase in inventory or receivables = deduct. Increase in payables = add. Decrease works in reverse.; Use only operating items. For a non-financial enterprise, keep investment sale debtors and fixed asset creditors out. For a financial enterprise, loans and advances and deposits (and related interest receivable or payable) are operating items, so include their changes here.
Tax paid: Tax paid = Opening provision for tax + Tax charged for the year − Closing provision for tax; If advance tax is shown as an asset, include its movement in the working. Show tax paid below cash generated from operations.
Fixed asset purchases: Purchases = Closing net block − Opening net block + Depreciation + Net book value of assets sold; This works only when there are no revaluations, impairments or capital work-in-progress adjustments. If the question gives any of these, adjust for them first. Proceeds on sale = Net book value + Profit (or − Loss). Proceeds go to investing inflows.
Debt and equity flows: Shares issued = Increase in share capital + Increase in securities premium (if cash issue). Borrowings raised or repaid = Change in borrowings, after non-cash conversions.; Exclude bonus shares and conversions of debentures into shares. These do not involve cash.
Classification rule (non-financial): Interest/dividend received → Investing. Interest/dividend paid → Financing.; This is ICAI's treatment for non-financial enterprises. Apply it consistently from period to period. For financial enterprises, interest paid, interest received and dividends received are operating; dividend paid is financing.

How to solve Preparing a Cash Flow Statement: Comprehensive Problems questions

Use the same sequence for every problem. It stops you from missing items and makes the final tie-out a built-in check.

1Read the additional information first. Mark every item as operating, investing, financing or non-cash. Note whether the enterprise is financial.
2Compute net profit before tax and extraordinary items. If the P&L account is not given, derive it from the change in the P&L balance, appropriations and the tax charge.
3Adjust for non-cash and non-operating items: add depreciation, amortisation and interest expense; deduct interest and dividend income and profit on sale; add losses. Keep these adjustments only for non-financial enterprises where AS 3 puts them in other sections.
4Adjust for changes in current assets and current liabilities to reach cash generated from operations. For a financial enterprise, also include changes in loans and advances and deposits, as these are operating items. Deduct tax paid, worked out using the provision account.
5Prepare working notes for fixed assets, investments, borrowings and capital. Use them to fill investing and financing sections with actual cash amounts only.
6Add up the three sections to get the net change. Add the opening cash and cash equivalents to get the closing figure.
7Check the closing figure against the balance sheet. Reconcile cash and cash equivalents with balance sheet items, and show the items you excluded and why.
8Show extraordinary items, if any, separately in the section they belong to. Disclose significant non-cash transactions separately.

Quickest way: Change-in-balance-sheet shortcut with a check total

When to use it: Use when the question gives only two balance sheets and brief adjustments, and time is short.

Write the cash line first (opening and closing). The net change is your target. If your three sections do not add to it, you have an error.
For MCQs, do not build the whole statement. Compute only the asked section. For tax paid use the provision formula. For fixed asset purchases use closing net block − opening + depreciation + book value sold, but only when there are no revaluations, impairments or capital work-in-progress adjustments. If any of these is given, adjust for it first.
Eliminate options quickly: an option that adds depreciation to investing is wrong. An option that deducts interest income from a financial enterprise's operating cash flow is normally wrong too, because AS 3 keeps it in operating for such enterprises.
In written answers, use a clean format: heading, three sections with sub-totals, net change, opening, closing. Put working notes at the end and label them (Working Note 1, 2 and so on).
Write each working note as a short formula with figures. Step marks go to correct sections and notes, even if one number is wrong.
Do the check total last. Any missing item usually shows up as a mismatch equal to a single balance sheet movement.

Common mistakes in Preparing a Cash Flow Statement: Comprehensive Problems

Taking the whole change in the P&L balance as profit before tax
Students forget that reserves transfers, dividends and tax were deducted from the P&L balance.
Fix: Add back transfers to reserves, dividend and the tax charge to the change in the P&L balance. Only then start the indirect method.
Showing tax at the P&L charge instead of tax actually paid
The provision account is skipped.
Fix: Use opening provision + charge − closing provision. Show it as a deduction after cash generated from operations.
Treating depreciation and fixed asset purchases as the same number
Students compare net blocks only.
Fix: Net block change is purchases less depreciation less book value of disposals. Add back depreciation and the book value of assets sold to find purchases.
Putting interest or dividend in the wrong section
The financial enterprise rule is mixed up with the non-financial rule.
Fix: Check the type of enterprise first. Financial enterprise: interest and dividends received, and interest paid, are operating. Non-financial: received is investing, paid is financing.
Counting a long-term fixed deposit or an investment as cash equivalents
Students treat anything liquid-looking as cash.
Fix: Include it only if it was a short-term, highly liquid investment with a maturity of about three months or less when acquired. Otherwise show it as investing.
Including non-cash items such as bonus shares or debenture conversion
Capital changes are copied from balance sheet differences.
Fix: Exclude them from financing flows. Disclose them separately as non-cash transactions.

Worked examples

Example 1

Non-financial company. Balance sheets as at 31 March 2026 and 31 March 2027 (₹): Equity share capital 5,00,000 / 6,00,000; General reserve 1,00,000 / 1,50,000; Profit and loss balance 80,000 / 1,30,000; 10% debentures 2,00,000 / 1,50,000; Trade payables 50,000 / 1,10,000; Provision for tax 40,000 / 50,000. Assets: Fixed assets (net) 5,00,000 / 6,40,000; Non-current investments 1,00,000 / 80,000; Inventory 1,20,000 / 1,50,000; Trade receivables 1,10,000 / 1,40,000; Cash and bank 1,40,000 / 1,80,000. Additional information: (a) depreciation charged ₹60,000, no fixed asset was sold; (b) investments costing ₹20,000 were sold for ₹25,000; (c) dividend income received ₹6,000 and interest on debentures paid ₹17,000, both included in profit; (d) tax charged for the year ₹55,000; (e) dividend paid ₹40,000; (f) shares were issued for cash at par; debentures were redeemed at par. Prepare the cash flow statement for the year ended 31 March 2027 using the indirect method.

Show the solution

Working note 1, profit before tax: Increase in P&L balance 50,000 + Transfer to general reserve 50,000 + Dividend paid 40,000 + Tax charge 55,000 = ₹1,95,000. Assumption: the ₹50,000 increase in general reserve is taken as a transfer from the P&L balance, with no other movement in reserves.
Working note 2, tax paid: Opening provision 40,000 + Charge 55,000 − Closing provision 50,000 = ₹45,000.
Working note 3, fixed asset purchases: 6,40,000 − 5,00,000 + 60,000 depreciation = ₹2,00,000.
Operating profit before working capital changes: 1,95,000 + Depreciation 60,000 + Interest 17,000 − Dividend income 6,000 − Profit on sale of investments 5,000 = ₹2,61,000.
Working capital changes: Inventory increase (30,000); Receivables increase (30,000); Payables increase +60,000. Net effect is nil. Cash generated from operations = ₹2,61,000. Less tax paid 45,000. Net cash from operating activities = ₹2,16,000.
Investing: Purchase of fixed assets (2,00,000); Sale of investments +25,000; Dividend received +6,000. Net cash used in investing = (₹1,69,000).
Financing: Shares issued +1,00,000; Debentures redeemed (50,000); Interest paid (17,000); Dividend paid (40,000). Net cash used in financing = (₹7,000).
Net increase in cash: 2,16,000 − 1,69,000 − 7,000 = ₹40,000. Opening 1,40,000 + 40,000 = Closing ₹1,80,000, which agrees with the balance sheet.

Answer: Operating ₹2,16,000; Investing (₹1,69,000); Financing (₹7,000). Net increase ₹40,000. Closing cash and cash equivalents ₹1,80,000.

Example 2

A finance company (a financial enterprise) gives these figures for the year (₹): Profit before tax 2,00,000, after interest received and paid and after dividend received of 10,000; depreciation 20,000; increase in loans and advances to customers 4,00,000; increase in customer deposits 6,00,000; increase in interest receivable 10,000; tax paid 60,000; purchase of fixed assets 50,000; purchase of investments 1,50,000; shares issued for cash 1,00,000; dividend paid 30,000. The purchase of investments of ₹1,50,000 excludes the treasury bills below, which are cash equivalents and not investments. Opening cash and cash equivalents: cash in hand 30,000, balances with banks 1,20,000. Closing: cash in hand 50,000, balances with banks 2,40,000, treasury bills with 3 months' original maturity 80,000. A fixed deposit of ₹1,00,000 with 9 months' original maturity was held at both the opening and the closing dates; it is not a cash equivalent. Prepare the cash flow statement and reconcile the cash balances.

Show the solution

As a financial enterprise, interest and dividends received and interest paid stay in operating. So no adjustment is made for them. Add back only depreciation: 2,00,000 + 20,000 = 2,20,000.
Working capital and operating items: Loans and advances increase (4,00,000); Deposits increase +6,00,000; Interest receivable increase (10,000). For a financial enterprise, loans and advances and deposits are operating items. 2,20,000 − 4,00,000 + 6,00,000 − 10,000 = 4,10,000.
Less tax paid 60,000. Net cash from operating activities = ₹3,50,000.
Investing: Purchase of fixed assets (50,000); Purchase of investments (1,50,000), which excludes the ₹80,000 treasury bills because they are cash equivalents. Net cash used in investing = (₹2,00,000). Dividend received is already in operating.
Financing: Shares issued +1,00,000; Dividend paid (30,000). Net cash from financing = ₹70,000.
Net increase: 3,50,000 − 2,00,000 + 70,000 = ₹2,20,000.
Reconciliation: Opening = 30,000 + 1,20,000 = 1,50,000. Closing = 50,000 + 2,40,000 + 80,000 = 3,70,000. Increase = 3,70,000 − 1,50,000 = 2,20,000, which agrees. The treasury bills are a component of cash equivalents, so their purchase is not an investing outflow.
The ₹1,00,000 fixed deposit is excluded from cash equivalents because its original maturity was more than three months. It stands at ₹1,00,000 at both opening and closing, so there is no purchase or redemption and no cash flow from it this year. Show it as an investment, not as part of cash and cash equivalents.

Answer: Operating ₹3,50,000; Investing (₹2,00,000); Financing ₹70,000. Net increase ₹2,20,000. Closing cash and cash equivalents ₹3,70,000. The 9-month fixed deposit of ₹1,00,000 is excluded.

Exam tips

Do the reconciliation of cash and cash equivalents with the balance sheet. It is a quick check and earns marks, and any excluded deposit should be explained.
Read the enterprise type before you classify interest and dividends. Financial enterprise questions test this rule very often.
In written answers, present working notes clearly and refer to them in the main statement. Partial marking rewards correct sections even if the total is off.
For MCQs, compute only the section asked. Tax paid, fixed asset purchases and proceeds from sale are the most common single-figure questions.
State your assumption when the question is silent, for example that tax is operating or that investments are non-cash-equivalents. A stated assumption protects your marks.

Practice questions from AS 3 Cash Flow Statement

Preparing a Cash Flow Statement: Comprehensive Problems in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Preparing a Cash Flow Statement: Comprehensive Problems: frequently asked questions

Should I use the direct or the indirect method in the exam?

Follow the question. If it does not say, the indirect method is the usual choice, as it starts from profit before tax and balance sheet data. AS 3 encourages the direct method but allows the indirect method.

Where do interest and dividends go in a cash flow statement?

For non-financial enterprises, as per ICAI's treatment, interest and dividends received are investing, and interest and dividends paid are financing. Apply the treatment consistently from period to period. For financial enterprises, interest paid, interest received and dividends received are operating, and dividend paid is financing.

How do I find profit before tax if the profit and loss account is not given?

Start with the change in the P&L balance. Add transfers to reserves, dividends and the tax charge for the year. The result is the profit before tax and extraordinary items, subject to any other appropriations given in the question.

What counts as a cash equivalent under AS 3?

A short-term, highly liquid investment that is readily convertible into a known amount of cash with insignificant risk of change in value. A three-month or shorter original maturity is the usual test. Deposits with a longer original maturity are investing items.