Corporate Accounting and Financial Management · Cash Flows

Classification of Cash Flows under AS 3 and Ind AS 7

Updated 11 October 2026 · Fact-checked

Classification of cash flows means sorting every cash inflow and outflow into operating, investing or financing activities. Operating covers main revenue-producing activity. Investing covers fixed assets and investments. Financing covers capital and borrowings. For a non-financial company, interest paid and dividends paid are financing; interest and dividends received are investing.

Understand AS 3 / Ind AS 7: Classification of Cash Flows

A cash flow statement reports only cash flows, which are inflows and outflows of cash and cash equivalents. It does not show profit. Its job is to show where cash came from and where it went during the year.

To make this useful, every cash flow is placed in one of three groups. Operating activities are the main revenue-producing activities of the entity, such as receipts from customers, payments to suppliers and employees, and income tax paid. Investing activities are buying and selling long-term assets and investments, such as plant, property and shares of other companies. Financing activities change the size and make-up of owners' capital and borrowings, such as issuing shares, taking or repaying loans, paying interest and paying dividends.

The tricky items are interest and dividends. Both standards say interest and dividends received and paid must each be disclosed separately. For a financial enterprise (financial institution under Ind AS 7), interest paid and interest and dividends received are operating cash flows. For any other entity, interest paid is a financing cash flow, and interest and dividends received are investing cash flows. Dividends paid are always financing. The standards reason that these are the cost of obtaining finance or the return on investments.

Note one difference. IAS 7 lets non-financial entities choose operating classification for these items. Ind AS 7 gives no such option; it requires financing and investing as above.

Under AS 3, cash flows linked to extraordinary items are classified as operating, investing or financing as appropriate and disclosed separately. The Ind AS framework does not use the concept of extraordinary items.

Key rules to remember

Three-way split: Net change in cash = Operating + Investing + Financing cash flows; Add the net cash from each group to get the net increase or decrease in cash and cash equivalents.
Interest paid (non-financial entity): Interest paid → Financing activities; Same under AS 3 (para 30) and Ind AS 7 (para 31). For a financial enterprise it is operating.
Interest and dividends received (non-financial entity): Interest received and dividends received → Investing activities; For a financial enterprise they are operating. Disclose each separately.
Dividends paid: Dividends paid → Financing activities; Applies to all entities.
Extraordinary items (AS 3): Extraordinary item cash flow → Operating, Investing or Financing as appropriate, shown separately; Classify by nature, not by the word extraordinary. AS 3 illustration shows insurance proceeds from earthquake settlement of 180 under operating.
Indirect method (Ind AS 7 para 20): Operating cash flow = Profit or loss ± changes in inventories, receivables and payables ± non-cash items ± items whose cash effects are investing or financing; Interest income, dividend income and interest expense are removed from profit and shown in their own groups.

How to solve AS 3 / Ind AS 7: Classification of Cash Flows questions

Use this routine for any question that asks you to classify cash flows or to build the three sections of a statement.

1Check the type of entity. Is it a financial enterprise or a non-financial one? This decides interest and dividends.
2List each item and ask: is it cash or non-cash? Drop depreciation, provisions, and unrealised exchange differences from the cash sections.
3Ask whether the item relates to the main revenue activity. If yes, it is operating (sales receipts, supplier payments, wages, tax paid).
4If it concerns buying or selling fixed assets or investments, or income earned on them (interest and dividends received), place it under investing.
5If it concerns raising or repaying capital or borrowings, or the cost of them (interest paid, dividends paid), place it under financing.
6Treat any extraordinary item by its nature and show it on a separate line in that group.
7Show inflows as positives and outflows in brackets. Total each group.
8Add the three totals and check that opening cash plus the net change equals closing cash.

Quickest way: Three-question sort

When to use it: Use when the question gives a list of items and asks you to tag each one in a short time.

Ask: does it touch long-term assets or investments? Then investing.
Ask: does it touch share capital or loans, or their cost (interest paid, dividend paid)? Then financing.
Everything else that is cash is operating.
Apply the exception only if the entity is financial: interest and dividends move to operating.
Cross out non-cash items such as depreciation and write-offs.

Common mistakes in AS 3 / Ind AS 7: Classification of Cash Flows

Showing interest paid as an operating outflow for a manufacturing company.
Interest is an expense in the profit and loss statement, so it feels operating.
Fix: For non-financial entities, interest paid is financing. Only financial enterprises treat it as operating.
Placing dividends received under financing.
Students link all dividends to financing because dividends paid are financing.
Fix: Dividends received are investing (non-financial entity). Dividends paid are financing.
Netting interest paid and interest received into one line.
Both are interest, so they look like one item.
Fix: The standards require interest and dividends received and paid to be disclosed separately. Show each on its own line in its own group.
Including depreciation or provisions as cash outflows.
They appear in the profit and loss account as expenses.
Fix: They are non-cash. Add them back in the indirect method; never show them as cash flows.
Leaving an extraordinary item out of the classification or lumping it with normal operating cash.
Students forget AS 3 wants separate disclosure.
Fix: Classify it by nature as operating, investing or financing and show it on a separate line.
Using the IAS 7 option to put interest in operating activities under Ind AS 7.
Some books cover IAS 7, which allows the choice.
Fix: Ind AS 7 gives no such option for non-financial entities. Use financing for interest paid and investing for interest and dividends received.

Worked examples

Example 1

A manufacturing company (not a financial enterprise) reports these cash items for the year (₹ in lakhs): cash received from customers 900; cash paid to suppliers and employees 640; income tax paid 60; purchase of plant 150; sale of old machinery 20; interest received 12; dividend received 8; proceeds of fresh share issue 100; repayment of term loan 70; interest paid 30; dividend paid 40. Classify and find the net cash from each activity.

Show the solution

Operating: 900 − 640 − 60 = 200.
Investing: −150 + 20 + 12 + 8 = −110. Interest and dividends received are investing for a non-financial entity.
Financing: 100 − 70 − 30 − 40 = −40. Interest paid and dividends paid are financing.
Net change in cash = 200 − 110 − 40 = 50.

Answer: Operating +₹200 lakhs; Investing −₹110 lakhs; Financing −₹40 lakhs; net increase in cash and cash equivalents ₹50 lakhs.

Example 2

State, with reasons, how each item is classified in the cash flow statement of (a) Alpha Ltd, a manufacturing company, and (b) Beta Finance Ltd, a financial enterprise: interest paid on borrowings, interest received on investments, dividends received on shares held.

Show the solution

Recall the rule: AS 3 para 30 and Ind AS 7 para 31 treat these differently for financial and other entities.
(a) Alpha Ltd is a non-financial entity. Interest paid is a cost of obtaining finance, so financing. Interest received and dividends received are returns on investments, so investing.
(b) Beta Finance Ltd is a financial enterprise. Interest paid, interest received and dividends received are all operating, because lending and investing are its main business.
In both cases each item is disclosed separately, not netted.

Answer: Alpha Ltd: interest paid is financing; interest received and dividends received are investing. Beta Finance Ltd: all three are operating. Each is shown separately.

Exam tips

Always state the entity type first. One line saying non-financial entity earns the mark for the interest rule.
Quote the rule in ICSI style: provision, application to the facts, then conclusion. Cite AS 3 para 30 or Ind AS 7 para 31 where relevant.
In a full statement, show interest paid, interest received and dividends on separate lines in their own groups.
Remember the indirect method adjustments: add back interest expense, subtract interest and dividend income from profit, then show them in financing and investing.
If the question names Ind AS 7, do not mention the IAS 7 operating option as available; it is not allowed under Ind AS 7.

Practice questions from Cash Flows

AS 3 / Ind AS 7: Classification of Cash Flows 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 / Ind AS 7: Classification of Cash Flows: frequently asked questions

Where does interest paid go in a cash flow statement?

For a non-financial entity it is a financing activity under both AS 3 and Ind AS 7. For a financial enterprise it is an operating activity. It must be disclosed separately.

Are dividends received operating or investing?

For entities other than financial enterprises, dividends received are investing cash flows. For a financial enterprise, they are operating cash flows.

How are extraordinary items treated in AS 3?

The cash flows are classified as operating, investing or financing as appropriate, and disclosed separately. This is in addition to the disclosures required by AS 5.

What is the difference between Ind AS 7 and IAS 7 on interest?

IAS 7 lets non-financial entities classify interest paid and interest and dividends received as operating. Ind AS 7 gives no such option and requires financing and investing respectively.