Financial Management and Business Data Analytics · Cash Flow Statement - Preparation and Analysis

How to Prepare a Cash Flow Statement from Financial Statements

Updated 10 October 2026 · Fact-checked

A cash flow statement shows how cash and cash equivalents changed during a year. To prepare it, start with net profit before tax, adjust for non-cash and non-operating items and working capital changes, add investing and financing flows, then reconcile the total with the opening and closing cash balances.

Understand Preparing a Complete Cash Flow Statement from Financial Statements

A balance sheet shows what you own and owe on one date. A profit and loss account shows profit, which is not the same as cash. A company can report a profit and still run short of cash because customers have not paid or because it bought machinery. The cash flow statement fills this gap. It explains why cash moved between two balance sheet dates.

AS 3 asks you to split every cash movement into three groups. Operating activities are the main revenue-producing activities. Investing activities are the purchase and sale of long-term assets and investments. Financing activities change the size of owners' capital and borrowings. The three totals together must equal the change in cash and cash equivalents.

You rarely get the cash flows directly. You get two balance sheets and some profit and loss data. So you work backwards. Each change in a balance sheet item (other than cash) has a cash effect. An increase in an asset uses cash. An increase in a liability or capital brings cash in. The working notes convert those changes into proper cash flows, for example finding fixed assets purchased or tax actually paid.

In the indirect method for operating activities, you start from net profit before tax and remove items that are not operating cash flows. These are depreciation, loss or profit on sale of assets, interest expense and investment income. Then you adjust for changes in current assets and current liabilities. The statement ends with a reconciliation: opening cash plus net increase or decrease equals closing cash.

Key rules to remember

Net change in cash: Net increase/(decrease) in cash = Operating CF + Investing CF + Financing CF; Must equal closing cash and cash equivalents minus opening cash and cash equivalents.
Operating profit before working capital changes: Net profit before tax + Depreciation + Loss on sale of assets − Profit on sale of assets + Interest expense − Interest and dividend income; Under AS 3, interest paid is normally shown under financing, and interest or dividend received under investing, for non-financial enterprises. Dividend paid is a financing outflow. The question's instruction prevails if it says otherwise.
Working capital adjustments: Increase in current assets: deduct. Decrease in current assets: add. Increase in current liabilities: add. Decrease in current liabilities: deduct.; Apply to inventory, receivables, prepaid items and payables. Cash is excluded.
Cash generated from operations: Cash generated from operations = Operating profit before working capital changes ± Working capital adjustments; Income tax paid is deducted after this line to get net cash from operating activities.
Tax paid: Tax paid = Opening provision + Tax charged to P&L − Closing provision; Use the provision account as a working note.
Fixed assets purchased: Purchases = Closing net block − Opening net block + Depreciation + Book value of assets sold; Use gross block and accumulated depreciation accounts if both are given.
Net profit before tax from reserves: Profit for the year = Closing P&L balance − Opening P&L balance + Transfers to reserves + Dividends; Use it when the profit figure is hidden in the change of the P&L balance. Tax must then be added back to get profit before tax.

How to solve Preparing a Complete Cash Flow Statement from Financial Statements questions

Follow the same order every time. It keeps the answer tidy and earns step marks even if one figure is wrong.

1Read the question for instructions: method (direct or indirect), treatment of interest and dividend, and any cash equivalents. Note the opening and closing cash balances first.
2Find net profit before tax. If it is not given, build it from the change in the P&L balance plus transfers, dividends and tax charged. Show this as Working Note 1.
3Prepare working notes for the fixed asset account (purchases or sale proceeds), provision for tax (tax paid), investments, and any share capital, debenture or loan movements.
4Write the operating section: start with profit before tax, add back non-cash and non-operating items, then adjust working capital changes. Deduct tax paid to get net operating cash flow.
5Write the investing section: purchase and sale of fixed assets and investments, plus interest and dividend received if applicable. Show outflows in brackets.
6Write the financing section: shares issued, loans raised or repaid, debentures redeemed, interest paid and dividend paid.
7Add the three totals to get the net change in cash. Reconcile with opening and closing cash. If it does not match, recheck the signs of working capital items and the working notes.

Quickest way: Change-in-balance-sheet tick method

When to use it: Use it when the question gives two balance sheets and a few notes, and you have about 15 to 20 minutes for 14 marks.

Make a column of changes (closing minus opening) next to every balance sheet item except cash.
Mark each change as operating, investing or financing. Current assets and liabilities go to operating. Fixed assets and investments go to investing. Capital, reserves and loans go to financing.
Handle the tricky items first: depreciation, tax provision and fixed assets sold. These need small working notes.
Write the statement top to bottom using the marked changes. Tick every change once, so nothing is missed or counted twice.
Verify by checking that the total of the three sections equals the change in cash. Do this check before you write the final reconciliation.

Common mistakes in Preparing a Complete Cash Flow Statement from Financial Statements

Treating an increase in current assets as an addition to cash.
Students match the direction of the balance sheet change instead of the effect on cash.
Fix: Remember that more inventory or receivables means cash is tied up, so deduct. More payables means you kept cash longer, so add.
Starting with net profit after tax or the P&L closing balance.
The question gives these figures and they look ready to use.
Fix: Start with net profit before tax and extraordinary items. Rebuild it from the P&L balance, transfers, dividend and tax charge, and show tax paid separately.
Adding back depreciation but forgetting the loss or profit on sale of an asset.
Students treat only depreciation as non-cash and ignore the asset sale.
Fix: Add back loss on sale and deduct profit on sale in the operating section. Show the full sale proceeds in investing.
Using the change in net block as the purchase of fixed assets.
Depreciation and assets sold reduce the net block, but this is overlooked.
Fix: Use the fixed asset working note: closing net block − opening net block + depreciation + book value of assets sold.
Deducting the tax charged to P&L instead of the tax actually paid.
The tax provision account is not prepared.
Fix: Prepare the provision account. Tax paid = opening provision + charge for the year − closing provision.
Leaving interest and dividend inside operating profit, or counting proposed dividend as paid.
Students are unsure where AS 3 places these items.
Fix: Add back interest expense, then show interest paid under financing, which is the normal AS 3 treatment for non-financial enterprises, unless the question instructs otherwise. Show dividend only when actually paid in the year, under financing.

Worked examples

Example 1

The summarised balance sheets of Kaveri Ltd are given below (₹ in lakh).

Liabilities: Equity share capital 10.00 (2026), 12.00 (2027). Profit and loss balance 3.00, 4.50. 12% Debentures 4.00, 3.00. Trade payables 1.50, 1.80. Total 18.50, 21.30.

Assets: Fixed assets (net) 9.00, 11.00. Investments 2.00, 1.00. Inventory 3.00, 3.50. Trade receivables 2.50, 3.00. Cash 2.00, 2.80. Total 18.50, 21.30.

Additional information: (a) Net profit for the year before dividend is 2.00 after charging depreciation of 1.00 and debenture interest of 0.48. Ignore tax. (b) Dividend paid is 0.50. (c) Investments were sold at cost. (d) No fixed asset was sold. (e) Debentures were redeemed at the year end and interest was paid in full. (f) Equity shares of 2.00 were issued for cash during the year. Prepare a cash flow statement as per AS 3 (indirect method).

Show the solution

Working Note 1, fixed assets purchased: closing net block 11.00 − opening 9.00 + depreciation 1.00 = 3.00. No asset was sold.
Working Note 2, profit: P&L balance moved from 3.00 to 4.50, an increase of 1.50. Adding dividend 0.50 gives profit 2.00, which agrees with the given figure.
Operating activities: net profit 2.00 + depreciation 1.00 + interest expense 0.48 = operating profit before working capital changes 3.48.
Working capital changes: increase in receivables (0.50), increase in inventory (0.50), increase in payables +0.30. Net effect (0.70).
Cash generated from operations = 3.48 − 0.70 = 2.78. There is no tax, so net operating cash flow is 2.78.
Investing activities: purchase of fixed assets (3.00), sale of investments +1.00. Net investing cash flow is (2.00).
Financing activities: shares issued for cash +2.00 (as given in (f); the share capital increase of 2.00 agrees), debentures redeemed (1.00), interest paid (0.48), dividend paid (0.50). Net financing cash flow is +0.02.
Net increase in cash = 2.78 − 2.00 + 0.02 = 0.80.
Reconciliation: opening cash 2.00 + increase 0.80 = closing cash 2.80, which agrees with the balance sheet.

Answer: Net cash from operating activities ₹2.78 lakh; investing activities (₹2.00 lakh); financing activities ₹0.02 lakh. Net increase in cash ₹0.80 lakh, taking cash from ₹2.00 lakh to ₹2.80 lakh.

Example 2

Extracts from the balance sheets of Mahadev Ltd (₹ in lakh), 2026 then 2027.

Share capital 20.00, 20.00. General reserve 5.00, 6.00. P&L balance 4.00, 5.50. Provision for tax 2.00, 2.50. Trade payables 3.00, 2.40. Term loan 6.00, 8.00. Total 40.00, 44.40.

Fixed assets (net) 24.00, 25.00. Inventory 6.00, 5.00. Trade receivables 5.00, 6.40. Cash 5.00, 8.00. Total 40.00, 44.40.

Additional information: (a) A machine with net book value 3.00 was sold for 2.20. (b) Depreciation charged was 2.50. (c) Tax paid during the year was 1.80. (d) 1.00 was transferred to general reserve and dividend of 1.00 was paid. (e) Interest on term loan of 0.90 was paid and charged to P&L. Prepare the cash flow statement (indirect method, interest and dividend paid under financing).

Show the solution

Working Note 1, tax charged: provision account. Opening 2.00 + charge for the year − tax paid 1.80 = closing 2.50. Charge = 2.50 + 1.80 − 2.00 = 2.30.
Working Note 2, profit after tax: closing P&L 5.50 = opening 4.00 + profit − transfer 1.00 − dividend 1.00. Profit after tax = 5.50 − 4.00 + 1.00 + 1.00 = 3.50.
Working Note 3, profit before tax = 3.50 + 2.30 = 5.80.
Working Note 4, fixed assets purchased: opening 24.00 − book value sold 3.00 − depreciation 2.50 + purchases = closing 25.00. Purchases = 6.50.
Loss on sale = 3.00 − 2.20 = 0.80.
Operating activities: profit before tax 5.80 + depreciation 2.50 + loss on sale 0.80 + interest 0.90 = 10.00.
Working capital: decrease in inventory +1.00, increase in receivables (1.40), decrease in payables (0.60). Net (1.00). Cash generated from operations = 9.00.
Tax paid (1.80). Net operating cash flow = 7.20.
Investing: purchase of fixed assets (6.50), sale proceeds +2.20. Net (4.30).
Financing: term loan raised +2.00, interest paid (0.90), dividend paid (1.00). Net +0.10.
Net increase in cash = 7.20 − 4.30 + 0.10 = 3.00. Opening cash 5.00 + 3.00 = closing cash 8.00, which agrees.

Answer: Net cash from operating activities ₹7.20 lakh; investing activities (₹4.30 lakh); financing activities ₹0.10 lakh. Net increase in cash ₹3.00 lakh, from ₹5.00 lakh to ₹8.00 lakh.

Exam tips

Show working notes clearly and label them. In a 14-mark question, examiners award marks for the notes on fixed assets, tax and profit even if the final total is wrong.
Use brackets for outflows and keep one column for amounts. Write the three section totals on separate lines, then the net change and the reconciliation with opening and closing cash.
Check the question for the treatment of interest, dividends and the method asked. If it says direct method, build receipts and payments instead of adjusting profit.
Look for traps in the additional information: sale of assets, proposed dividend, bonus shares, provision for tax and non-cash transactions such as shares issued for assets. Handle each deliberately.
Finish with the cash check. If the sections do not add up to the change in cash, recheck the sign of each working capital item before anything else.

Practice questions from Cash Flow Statement - Preparation and Analysis

Preparing a Complete Cash Flow Statement from Financial Statements 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 Complete Cash Flow Statement from Financial Statements: frequently asked questions

How do I prepare a cash flow statement from two balance sheets?

Find the change in every balance sheet item except cash. Classify each change as operating, investing or financing, and convert it into a cash flow using working notes. The three section totals must equal the change in cash.

Which method is used in CMA Intermediate practical questions?

Most questions ask for the indirect method, starting from net profit before tax. Read the question, because some ask for the direct method or for operating activities only. The investing and financing sections are the same in both.

Where do interest and dividend go in the cash flow statement as per AS 3?

For a non-financial enterprise, interest paid is normally shown under financing activities, and interest or dividend received under investing activities. Dividend paid is a financing outflow. Follow any specific instruction given in the question, as it prevails.

What working notes are usually needed?

The common ones are the fixed asset account, provision for tax account, calculation of profit before tax from the P&L balance, and movements in investments and long-term borrowings. Each note gives a figure that goes into the statement.

What if my closing cash does not match the balance sheet?

Recheck the direction of working capital changes, tax paid and fixed asset purchases. Also check that you added back depreciation and any loss on sale, and that dividend was taken only if paid.