Corporate Accounting and Financial Management · Cash Flows

How to Prepare a Cash Flow Statement: Practical Problems

Updated 11 October 2026 · Fact-checked

To prepare a cash flow statement, start from profit, adjust for non-cash items and working capital changes to get operating cash flow, then list investing and financing flows from balance sheet changes. Check that the net change in cash matches the opening and closing cash and cash equivalents in the balance sheet.

Understand Preparing a Cash Flow Statement: Practical Problems

A cash flow statement shows where cash came from and where it went during a year. Profit is not cash. Credit sales, unpaid expenses, depreciation and stock changes all make profit differ from cash. The statement bridges that gap.

You are given two balance sheets and some profit and loss data. Every balance sheet item that changed must be explained by a profit item, a cash flow or a non-cash entry. That is why this question type is mechanical once you learn the routine.

The flows fall into three groups: operating (day-to-day business), investing (buying and selling long-term assets and investments) and financing (share capital, borrowings, dividends and interest paid by a non-financial company). Under the indirect method, you start with profit and adjust it. Ind AS 7 (para 20) lists the adjustments: changes in inventories and operating receivables and payables, non-cash items such as depreciation and provisions, and items whose cash effect belongs to investing or financing.

The last step is the reconciliation. The statement must end with closing cash and cash equivalents that agree with the balance sheet. Both AS 3 (para 42) and Ind AS 7 (para 45) require you to disclose the components of cash and cash equivalents and reconcile them with the balance sheet items.

Working notes are your safety net. They are not part of the published statement, but they show how each figure was derived. The AS 3 illustration says so itself. In an exam, they earn marks even if one figure goes wrong.

Key rules to remember

Indirect method start: Cash from operations = Profit before tax + non-cash expenses (depreciation) + finance costs − investment income ± loss/gain on sale of assets ± changes in working capital; Para 20 of Ind AS 7 lists these adjustments. Remove interest here only if you show it under financing.
Working capital effect: Increase in receivables or inventories = deduct. Decrease = add. Increase in payables = add. Decrease = deduct.; Use operating items only. Do not mix in loans or investments.
Income tax paid: Tax paid = Tax expense for the year + Opening tax liability − Closing tax liability; The AS 3 illustration: 300 + 1,000 − 400 = 900.
Interest paid: Interest paid = Interest expense + Opening interest payable − Closing interest payable; The AS 3 illustration: 400 + 100 − 230 = 270.
Purchase of fixed assets: Purchases = Closing gross block − Opening gross block + Original cost of assets sold; Use gross cost, not net book value, unless depreciation is added back separately.
Net change and reconciliation: Operating + Investing + Financing = Net change in cash. Opening cash + Net change = Closing cash and cash equivalents; The closing figure must agree with the balance sheet (Ind AS 7 para 45; AS 3 para 42).

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

Use this routine for any comparative balance sheet problem. Do the working notes first and the statement last.

1Read the extra information first. Note the dividend, interest, tax, asset sales and share or loan issues. Decide the standard (AS 3 or Ind AS 7) and the method the question asks for.
2Identify cash and cash equivalents on both balance sheets. Work out opening, closing and the net change you need to explain.
3Find the profit figure. Rebuild profit before tax from the reserves movement if needed: closing reserves − opening reserves + dividend paid (+ tax if charged).
4Prepare working notes: fixed assets and depreciation, tax paid, interest paid, and any loan or share capital movement.
5Write operating activities: profit, add back non-cash and finance items, then adjust each working capital item for its change.
6Write investing activities (asset purchases, sale proceeds, investment income) and financing activities (shares, borrowings, repayments, dividends, interest paid).
7Add the three totals to get the net change. Add it to opening cash and agree it to closing cash. Show the components of cash and cash equivalents. If it does not agree, recheck the signs on working capital.

Quickest way: Balance sheet change sweep

When to use it: Use when time is short and the data is clean. It also works as a final check.

Go down the balance sheet line by line and write the change in each item. Do not skip any.
Mark each change as source of cash (liability up, asset down) or use of cash (asset up, liability down).
Tag each line as operating, investing or financing. Reserves split into profit and dividend.
Fix non-cash lines (depreciation, write-offs, bonus shares) before you tag them.
The total of all tagged lines must equal the change in cash. This is your proof.

Common mistakes in Preparing a Cash Flow Statement: Practical Problems

Deducting an increase in payables or adding an increase in receivables.
Students think 'increase' always means add. The sign depends on whether the item is an asset or a liability.
Fix: Think in cash terms. More receivables means cash not yet collected, so deduct. More payables means cash not yet paid, so add.
Using net profit instead of profit before tax as the starting figure.
The balance sheet shows only the reserves movement, so students use that directly.
Fix: Rebuild profit before tax and show tax paid separately, from the tax working note.
Showing interest or dividend twice, once as an add-back and again in profit.
Students add back finance cost but also leave it in as cash paid in operations.
Fix: Add back interest expense in operations, then show interest actually paid in financing (or as your chosen classification), not both.
Treating the sale of a fixed asset at its book value as a profit.
They confuse sale proceeds with gain.
Fix: Compute book value = cost − accumulated depreciation. Gain or loss is proceeds − book value. Show only proceeds in investing and adjust any gain or loss in operations.
Including non-cash items such as depreciation in investing activities.
Depreciation changes the fixed asset line, so students look for a cash flow there.
Fix: Depreciation is only an add-back in operations. Purchases are found by the fixed asset working note.
Closing cash does not agree and no reconciliation is shown.
Students stop after the three sections.
Fix: Always finish with opening cash + net change = closing cash, and list the components of cash and cash equivalents.

Worked examples

Example 1

Alpha Ltd (₹ in lakh). Balance sheet at 31 March 2027 (2026 in brackets): Equity share capital 500 (400); Reserves 330 (250); Long-term borrowings 200 (250); Trade payables 120 (100). Assets: Fixed assets (net) 600 (500); Inventories 180 (200); Trade receivables 250 (170); Cash and cash equivalents 120 (130). Additional information: profit before tax and nil tax is 110 after charging depreciation of 60 and interest of 20. Interest of 20 was paid in cash. Dividend paid was 30. Prepare a cash flow statement (indirect method). Treat interest paid as financing.

Show the solution

Fixed asset working note: Opening 500 + Purchases − Depreciation 60 = Closing 600. So purchases = 160.
Reserves check: 250 + 110 − 30 = 330. This agrees.
Operating profit before working capital changes: 110 + 60 + 20 = 190.
Working capital: receivables up 80 (deduct 80); inventories down 20 (add 20); payables up 20 (add 20). Cash from operations = 190 − 80 + 20 + 20 = 150. Tax is nil, so net cash from operating activities is 150.
Investing: purchase of fixed assets (160). Net investing = (160).
Financing: shares issued 100; borrowings repaid (50); interest paid (20); dividend paid (30). Net financing = 100 − 50 − 20 − 30 = 0.
Net change in cash = 150 − 160 + 0 = (10).
Reconciliation: opening 130 − 10 = closing 120. This agrees with the balance sheet.

Answer: Operating activities 150; investing activities (160); financing activities 0. Net decrease in cash and cash equivalents is ₹10 lakh, from ₹130 lakh to ₹120 lakh.

Example 2

Using AS 3 illustration data (₹ '000): income tax expense for the year 300, income tax payable 1,000 at the start and 400 at the end; interest expense 400, interest payable 100 at the start and 230 at the end; plant with original cost 80 and accumulated depreciation 60 was sold for 20; fixed assets acquired for cash 350; cash on hand and bank balances 200 (25 last year), short-term investments 670 (135 last year). Prepare the working notes for tax paid, interest paid and the sale of plant, and the cash and cash equivalents reconciliation.

Show the solution

Tax paid = 300 + 1,000 − 400 = 900. In the illustration, 40 of this is tax deducted at source on dividends received, shown in investing. The balance of 860 is in operating activities.
Interest paid = 400 + 100 − 230 = 270. This agrees with the information: 170 for the current period plus 100 for the prior period.
Plant sold: book value = 80 − 60 = 20. Sale proceeds are 20, so there is no gain or loss. Show 20 as an inflow in investing activities.
Fixed assets purchased for cash: 350, shown as an outflow in investing activities.
Cash and cash equivalents at the end = 200 + 670 = 870. At the start = 25 + 135 = 160.
Net increase before any exchange rate effect = 870 − 160 = 710. Disclose the components and reconcile to the balance sheet (AS 3 para 42).

Answer: Tax paid 900 (860 operating, 40 investing); interest paid 270; plant sale proceeds 20 with nil gain or loss; capital expenditure (350). Cash and cash equivalents are 160 at the start and 870 at the end, an increase of 710.

Exam tips

Show every working note neatly and label it. Marks are awarded for method even if one figure is wrong.
State whether you are following AS 3 or Ind AS 7. Follow the question's required classification for interest and dividends.
Always end with the reconciliation of closing cash to the balance sheet and list the components of cash and cash equivalents.
Keep the sign convention in a column of brackets for outflows. Total each section separately.
If the question does not give profit before tax, rebuild it from the reserves movement. Do this before you start the statement.

Practice questions from Cash Flows

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

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

First find the profit and the net change in cash. Then do working notes for fixed assets, tax and interest. Build operating, investing and financing sections from the changes. Finish by agreeing opening cash plus net change to closing cash.

Do I add back depreciation in the cash flow statement?

Yes, under the indirect method. Depreciation reduced profit but did not use cash, so you add it back in operating activities. Ind AS 7 para 20 lists depreciation as a non-cash item.

Is the direct or the indirect method asked in CS Executive?

Read the question. The indirect method, starting from profit, is the one most commonly practised. If the question asks for the direct method, show cash receipts from customers and cash paid to suppliers and employees.

Where do I show interest and dividend paid?

For a non-financial company, interest and dividends paid are usually shown in financing activities. Follow the classification the question or standard requires. Be consistent, and do not count the same item twice.

Do working notes need to be published?

No. The AS 3 illustration says working notes do not form part of the cash flow statement and need not be published. In an exam, you should still write them because they show your method.