Corporate Accounting and Auditing · Cash Flow Statement

Introduction to Cash Flow Statement (AS 3 / Ind AS 7)

Updated 10 October 2026 · Fact-checked

A cash flow statement reports the historical inflows and outflows of cash and cash equivalents during a period, classified into operating, investing and financing activities. AS 3 and Ind AS 7 require it. To answer questions, first identify what counts as cash or cash equivalents, then classify each flow.

Understand Introduction to Cash Flow Statement (AS 3 / Ind AS 7)

Profit is not cash. A company can show a profit and still run short of money because customers have not paid, or stock has piled up. A cash flow statement fills this gap. It shows how cash moved in and out during the year.

Both AS 3 (Cash Flow Statements) and Ind AS 7 (Statement of Cash Flows) cover this. AS 3 says the statement should report cash flows during the period classified by operating, investing and financing activities. AS 3 also says an enterprise should prepare it and present it for each period for which financial statements are presented. Under the Companies Act, 2013, financial statements include the cash flow statement. For a one person company, small company and dormant company, financial statements may not include it. AS 3 is not mandatory for Micro, Small and Medium sized non-company enterprises (Levels IV, III and II), but they are encouraged to comply.

The standards define cash equivalents as short-term, highly liquid investments that are readily convertible to known amounts of cash and are subject to an insignificant risk of changes in value. Cash means cash in hand and demand deposits. Because moving money between cash and cash equivalents is part of cash management, such movements are not cash flows. Buying a liquid money-market investment that qualifies as a cash equivalent with surplus cash does not appear in the statement.

The benefits, in the standards' words, are these. Used with the other financial statements, it helps users evaluate changes in net assets, the financial structure (including liquidity and solvency) and the ability to affect the amounts and timing of cash flows. It helps assess the ability to generate cash and cash equivalents, and to compare the present value of future cash flows of different entities. It improves comparability because it removes the effect of different accounting treatments for the same transactions. Historical cash flows also indicate the amount, timing and certainty of future cash flows, help check past estimates, and show the link between profit and net cash flow.

A fund flow statement differs. It explains changes in working capital or financial position between two dates, usually on a working capital basis. A cash flow statement explains only the change in cash and cash equivalents. Limitations of the cash flow statement: it is historical, it does not replace the profit and loss account (non-cash items like accrual-based profit are not shown), and cash balance alone does not show overall liquidity, because the entity may have unused credit facilities or near-term payables.

Key rules to remember

Classification of cash flows: Net change in cash = Operating + Investing + Financing cash flows; Every cash flow is classified into one of these three activities.
Closing cash reconciliation: Opening cash and cash equivalents + Net increase (or − net decrease) = Closing cash and cash equivalents; The closing figure must agree with cash and cash equivalents in the balance sheet.
Cash equivalent test: Short-term + highly liquid + convertible to known amount of cash + insignificant risk of change in value; All the conditions must be met. An investment failing any one is not a cash equivalent.
Movements within cash: Transfer between cash and cash equivalents = not a cash flow; These are part of cash management and are excluded.

How to solve Introduction to Cash Flow Statement (AS 3 / Ind AS 7) questions

Use this method for theory questions and for the first screening of items in a numerical question.

1Read the question and note whether it asks for objectives, benefits, limitations, definitions, scope or a comparison.
2For definitions, write the cash equivalent test in full: short-term, highly liquid, readily convertible to known amounts of cash, insignificant risk of change in value.
3For scope, state who must prepare the statement and mention the exemptions for one person, small and dormant companies and the MSME position under AS 3.
4For any item, ask first: is it cash or a cash equivalent? If it is a movement between these, exclude it.
5Classify the real cash flow as operating, investing or financing.
6For comparison questions, use a point-wise two-column style: basis, cash flow statement, fund flow statement.
7Close with a one-line conclusion linking the statement to user decisions such as liquidity and solvency.

Quickest way: Three-check screening for any item

When to use it: Use it in MCQs asking whether an item is a cash flow, a cash equivalent, or which activity it belongs to.

Check 1: Is the item cash or a genuine cash equivalent? If it moves only between cash and cash equivalents, reject it.
Check 2: Is there an actual cash inflow or outflow? Non-cash items such as depreciation do not qualify.
Check 3: Pick the activity: day-to-day business is operating, long-term assets and investments are investing, owners' capital and borrowings are financing.

Common mistakes in Introduction to Cash Flow Statement (AS 3 / Ind AS 7)

Treating every short-term investment as a cash equivalent.
Students focus on 'short-term' and ignore the other conditions.
Fix: Apply all four parts of the test. The investment must be highly liquid, convertible to known amounts of cash and subject to only an insignificant risk of change in value.
Showing transfer from bank to a qualifying cash equivalent as an investing outflow.
It looks like buying an investment.
Fix: Movements between cash and cash equivalents are cash management and are excluded from cash flows.
Calling a cash flow statement the same as a fund flow statement.
Both deal with inflows and outflows.
Fix: State that the cash flow statement explains the change in cash and cash equivalents, while a fund flow statement explains changes in working capital or financial position.
Saying all companies must prepare a cash flow statement.
Students remember the general rule only.
Fix: Add that one person, small and dormant companies may be outside the requirement, and that AS 3 is not mandatory for MSME non-company entities.
Writing only benefits and skipping limitations when asked for both.
The standards list benefits clearly, but limitations are not given as a list.
Fix: Prepare two or three limitations: it is historical, it does not replace the profit and loss account, and cash balance alone does not show full liquidity.

Worked examples

Example 1

State the definition of cash equivalents under Ind AS 7. A company invested surplus cash in a highly liquid instrument that is readily convertible to known amounts of cash and has an insignificant risk of change in value. Is this investment itself a cash flow in the statement?

Show the solution

Definition: cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and are subject to an insignificant risk of changes in value.
The instrument in the question meets the liquidity, convertibility and risk conditions. Assuming it is also short-term, it qualifies as a cash equivalent.
Purchasing a cash equivalent with cash is a movement between items that constitute cash and cash equivalents.
Such movements are part of cash management, not operating, investing or financing activities.

Answer: Cash equivalents are short-term, highly liquid investments readily convertible to known amounts of cash with insignificant risk of change in value. The purchase is not a cash flow and is excluded from the statement.

Example 2

Distinguish between a cash flow statement and a fund flow statement in four points, and state two benefits of a cash flow statement.

Show the solution

Purpose: the cash flow statement explains the change in cash and cash equivalents; a fund flow statement explains the change in financial position, usually working capital.
Basis: the cash flow statement is prepared on a cash basis; a fund flow statement is usually on a working capital basis.
Classification: the cash flow statement classifies flows into operating, investing and financing activities; a fund flow statement shows sources and applications of funds.
Opening and closing: the cash flow statement starts with opening cash and cash equivalents and ends with the closing balance; a fund flow statement does not reconcile cash.
Benefit 1: it helps users assess the ability to generate cash and cash equivalents and their liquidity and solvency.
Benefit 2: it improves comparability between entities because it removes the effect of different accounting treatments for the same transactions.

Answer: The four points are purpose, basis, classification and reconciliation as above. Benefits: assessment of cash generation, liquidity and solvency, and better comparability between entities.

Exam tips

For definition questions, reproduce all conditions of cash equivalents. Missing one condition loses the mark.
In MCQs, watch for options that treat movements between cash and cash equivalents as cash flows. They are wrong.
Use a two-column layout for 'difference between' questions; it earns step marks.
Mention both AS 3 and Ind AS 7 when the question does not say which applies.
Link every benefit to a user decision such as liquidity, solvency or forecasting future cash flows.

Practice questions from Cash Flow Statement

Introduction to Cash Flow Statement (AS 3 / Ind AS 7) in other exams

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

Introduction to Cash Flow Statement (AS 3 / Ind AS 7): frequently asked questions

What is the difference between AS 3 and Ind AS 7?

AS 3 is the Cash Flow Statements standard, and Ind AS 7 is the Statement of Cash Flows standard. Both require classification into operating, investing and financing activities and use the same definition of cash equivalents. Which one applies depends on whether the entity follows Accounting Standards or Ind AS.

What is the definition of cash equivalents?

Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and subject to an insignificant risk of changes in value. All parts of the definition must be met.

Do all companies need a cash flow statement?

Financial statements under the Companies Act, 2013 include the cash flow statement. However, a one person company, small company and dormant company may not need to include it. AS 3 is also not mandatory for MSME non-company entities, though they are encouraged to comply.

How is a cash flow statement different from a fund flow statement?

A cash flow statement explains the movement in cash and cash equivalents in three activity groups. A fund flow statement explains changes in working capital or financial position, showing sources and applications of funds.