Corporate Accounting and Financial Management · Accounting Standards

AS 3 Cash Flow Statement: Indirect Method and Activities

Updated 11 October 2026 · Fact-checked

A cash flow statement under AS 3 reports cash and cash equivalents moving in and out during a period, split into operating, investing and financing activities. For the indirect method, start with net profit before tax, adjust for non-cash and non-operating items and working capital changes, then add investing and financing flows.

Understand AS 3 Cash Flow Statements

A balance sheet shows what a company owns and owes on one date. A profit and loss statement shows profit, which is not the same as cash. A company can show profit and still run short of cash. The cash flow statement fills this gap.

The Preface to the Accounting Standards lists a cash flow statement (wherever applicable) as part of general purpose financial statements. The Conceptual Framework adds why it matters: information about cash flows helps users assess the entity's ability to generate future net cash inflows, its liquidity or solvency, and how it obtains and spends cash, including borrowing, repayment of debt and dividends.

AS 3 groups all cash flows into three activities.

Operating activities: the main revenue-producing activities of the business, such as cash from customers, payments to suppliers and employees, and income tax paid.
Investing activities: buying and selling fixed assets and long-term investments, and interest and dividends received on them.
Financing activities: changes in the size and make-up of owners' capital and borrowings, such as issuing shares, raising or repaying loans, and paying dividends.

The statement explains the change in cash and cash equivalents. Cash means cash in hand and demand deposits. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and carry little risk of value change. Movements between cash and cash equivalents are not cash flows.

There are two ways to report operating activities. In the direct method you show gross cash receipts and payments. In the indirect method you start with net profit and adjust it to arrive at cash from operations. Investing and financing sections are the same under both. Exams mostly ask for the indirect method.

Key rules to remember

Net change in cash: Net increase or decrease in cash = Operating + Investing + Financing cash flows; Must equal closing cash and cash equivalents minus opening cash and cash equivalents. Use this as your final check.
Operating profit before working capital changes: Net profit before tax and extraordinary items + Depreciation + Interest expense + Loss on sale of assets − Interest and dividend income − Profit on sale of assets; Add back non-cash and financing items. Remove investing items. Interest and dividend income are shown under investing.
Cash generated from operations: Operating profit before working capital changes − Increase in current assets + Decrease in current assets + Increase in current liabilities − Decrease in current liabilities; Use only operating current assets and liabilities. Exclude cash, cash equivalents and items that are investing or financing in nature.
Net cash from operating activities: Cash generated from operations − Income tax paid; Taxes paid are normally shown here unless they can be specifically identified with investing or financing activities.
Tax paid: Tax paid = Opening tax payable + Tax charged to profit − Closing tax payable; Use this when the tax charged and the balance sheet balances are given.
Fixed asset sale proceeds: Sale proceeds = Book value of asset sold ± Profit or loss on sale; Book value is found from the asset account or by reconstructing it with accumulated depreciation.
Cash and cash equivalents: Closing cash and cash equivalents = Opening balance + Net increase (or − net decrease); Reconcile this with the balance sheet figures.

How to solve AS 3 Cash Flow Statements questions

Use the same order every time. It keeps the question organised and lets you pick up marks for each section even if one figure goes wrong.

1Read the question and note which items count as cash and cash equivalents. Calculate opening and closing cash and cash equivalents first.
2Work out the change in every balance sheet item between the two years. Note whether each change is a source or a use of cash.
3Start the operating section with net profit before tax. If only net profit after tax is given, add back the tax charged for the year.
4Add back non-cash and non-operating charges such as depreciation, interest expense, loss on sale and amounts written off. Deduct profits on sale and interest or dividend income.
5Adjust for changes in operating current assets and current liabilities to reach cash generated from operations. Deduct tax paid to get net cash from operating activities.
6Prepare the investing section: purchase and sale of fixed assets and investments, plus interest and dividends received. Use working notes for asset accounts.
7Prepare the financing section: shares issued, loans raised or repaid, interest paid and dividends paid.
8Total the three sections, add the opening cash and cash equivalents, and check that the result equals the closing balance.

Quickest way: Balance sheet difference method

When to use it: Use this when you are given two balance sheets with a few adjustments and have little time.

Make a two-column table of changes for each balance sheet line and mark each as a source or a use of cash.
Tick off items already covered by the adjustments, such as depreciation or sale of assets, so you do not count them twice.
Slot each remaining change into operating, investing or financing straight away.
Write only the working notes you need: fixed assets, tax and, if given, dividend or interest.
Total the sections and check against the change in cash. If it does not match, recheck the accumulated depreciation and tax notes first.

Common mistakes in AS 3 Cash Flow Statements

Starting the operating section with net profit after tax and forgetting to add back tax.
The profit figure in the balance sheet is often after tax and appropriations, so students use it unchanged.
Fix: Rebuild profit before tax: add the tax provision for the year, and add back dividends and transfers to reserves if the profit figure is the closing balance of the Profit and Loss account.
Showing depreciation as a cash outflow or deducting it again.
It is an expense in the profit statement, so students treat it like any other payment.
Fix: Depreciation uses no cash. Add it back to profit in the operating section only.
Putting interest or dividend received in operating activities and interest paid in financing without a reason.
Students mix up where each item belongs.
Fix: Add back interest expense in the operating adjustments and show interest paid as a financing outflow. Remove interest and dividend income and show it as an investing inflow, following AS 3 for non-financial companies.
Taking the sale of a fixed asset at its book value instead of actual proceeds.
Students overlook the profit or loss on sale given in the question.
Fix: Compute proceeds as book value plus profit or minus loss. Show the proceeds in investing and reverse the profit or loss in operating.
Counting changes in cash or cash equivalents among current assets in the working capital adjustments.
Students adjust every current item without separating the cash items.
Fix: Exclude cash and cash equivalents from the working capital changes. They are what the statement reconciles.
Treating bonus shares, or shares issued for a non-cash asset, as financing cash inflows.
The share capital line has increased, so students show a cash receipt.
Fix: Non-cash transactions are not shown in the statement. Exclude them and disclose them separately if required.

Worked examples

Example 1

From the following data of Ganga Ltd., compute cash generated from operations and net cash from operating activities by the indirect method. Net profit before tax ₹5,00,000 (after charging depreciation ₹80,000, interest expense ₹30,000 and a loss on sale of machinery ₹10,000, and after crediting interest income ₹20,000). Increase in trade receivables ₹60,000. Decrease in inventories ₹25,000. Increase in trade payables ₹40,000. Income tax paid ₹1,10,000.

Show the solution

Start with net profit before tax: ₹5,00,000.
Add non-cash and financing charges: depreciation ₹80,000, interest expense ₹30,000, loss on sale ₹10,000. Total added back = ₹1,20,000.
Deduct interest income ₹20,000, as it is shown under investing activities.
Operating profit before working capital changes = 5,00,000 + 1,20,000 − 20,000 = ₹6,00,000.
Working capital changes: increase in receivables −₹60,000; decrease in inventories +₹25,000; increase in payables +₹40,000. Net = +₹5,000.
Cash generated from operations = 6,00,000 + 5,000 = ₹6,05,000.
Less income tax paid ₹1,10,000: net cash from operating activities = 6,05,000 − 1,10,000 = ₹4,95,000.

Answer: Cash generated from operations is ₹6,05,000 and net cash from operating activities is ₹4,95,000.

Example 2

Yamuna Ltd. had cash and cash equivalents of ₹1,20,000 at the start of the year. During the year: net cash from operating activities was ₹3,50,000; machinery costing ₹4,00,000 was bought for cash; old machinery with book value ₹90,000 was sold at a loss of ₹15,000; interest received was ₹12,000; equity shares of ₹2,00,000 were issued at par for cash; a long-term loan of ₹1,00,000 was repaid; interest paid was ₹25,000; dividend paid was ₹40,000. Prepare the investing and financing sections and find the closing cash and cash equivalents.

Show the solution

Sale proceeds of machinery = book value 90,000 − loss 15,000 = ₹75,000.
Investing activities: purchase of machinery −₹4,00,000; sale proceeds +₹75,000; interest received +₹12,000.
Net cash used in investing = −4,00,000 + 75,000 + 12,000 = −₹3,13,000.
Financing activities: shares issued +₹2,00,000; loan repaid −₹1,00,000; interest paid −₹25,000; dividend paid −₹40,000.
Net cash from financing = 2,00,000 − 1,00,000 − 25,000 − 40,000 = +₹35,000.
Net increase in cash = 3,50,000 − 3,13,000 + 35,000 = ₹72,000.
Closing cash and cash equivalents = opening 1,20,000 + 72,000 = ₹1,92,000.

Answer: Net cash used in investing is ₹3,13,000, net cash from financing is ₹35,000, net increase in cash is ₹72,000 and closing cash and cash equivalents are ₹1,92,000.

Exam tips

Write the heading of each section clearly: operating, investing and financing. Marks are awarded for correct classification even when a figure is wrong.
Show working notes for fixed assets, tax paid and any reconstructed accounts. Examiners give marks for method.
Always reconcile with the opening and closing cash and cash equivalents given in the balance sheet. State the reconciliation at the end.
Write theory answers in a structured way: define the statement, name the three activities, give two examples of each, and state whether you use the direct or indirect method.
Look for adjustments that look like cash items but are not, such as bonus shares, depreciation and provisions. Decide quickly whether each belongs in the statement.

Practice questions from Accounting Standards

AS 3 Cash Flow Statements in other exams

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

AS 3 Cash Flow Statements: frequently asked questions

What is the difference between the direct and indirect method under AS 3?

The direct method shows gross cash receipts and payments from operations. The indirect method starts with net profit and adjusts it for non-cash items, non-operating items and working capital changes. Both give the same net cash from operating activities. Investing and financing sections are the same under both.

Where do I show interest and dividend received and paid?

For a company other than a financial one, show interest and dividend received as investing inflows. Show interest paid and dividend paid as financing outflows. When you start from profit, add back interest expense and remove interest and dividend income in the operating section.

Is depreciation a cash flow?

No. Depreciation is a non-cash expense. It reduces profit but does not use cash, so you add it back when starting from net profit in the indirect method. It never appears in investing or financing.

How are cash equivalents treated in the cash flow statement?

Cash equivalents are short-term, highly liquid investments that can be converted into known amounts of cash with little risk of value change. They are treated like cash. Movements between cash and cash equivalents are not shown as cash flows. The statement explains the change in their total.