Cash Flow Statement by the Indirect Method: A Complete Worked Example
Profit is not the same as cash generated. Follow a fully reconciled example showing how operating adjustments, investments and financing explain the movement in cash.
AI Summary
Scope: AS 3 example for a non-financial enterprise; first assess whether a cash flow statement is required for the entity. Verification date: 11 October 2026.
Why profit and cash move differently
A profitable company can face cash pressure because customers have not paid, stock has increased or loans have been repaid. The cash flow statement explains these movements. Under the indirect method, operating cash flow starts with profit and adjusts for non-cash items and relevant accrual movements.
This example uses AS 3, rather than Ind AS 7, and a fictional non-financial enterprise. Interest paid is shown under financing activities. Non-cash investing or financing transactions do not become cash flows merely because an asset or liability balance changes.
The facts for the year
Assume profit before tax is ₹10 lakh. Depreciation is ₹2 lakh, interest expense is ₹1 lakh and a machine sale generated a ₹0.50 lakh gain. Trade receivables increased by ₹3 lakh, inventory increased by ₹1 lakh and operating trade payables increased by ₹2 lakh. Income taxes actually paid were ₹1.50 lakh.
The company paid ₹5 lakh for new machinery and received ₹1.50 lakh from the machine sale. It received a new loan of ₹4 lakh, repaid loan principal of ₹2 lakh and paid interest of ₹1 lakh. There are no other flows or exchange effects in this simplified example.
Step 1: calculate operating cash flow
| Particulars | ₹ lakh |
|---|---|
| Profit before tax | 10.00 |
| Add depreciation | 2.00 |
| Add interest expense | 1.00 |
| Remove gain on machine sale | (0.50) |
| Operating profit before working-capital changes | 12.50 |
| Increase in receivables | (3.00) |
| Increase in inventory | (1.00) |
| Increase in operating payables | 2.00 |
| Cash generated from operations | 10.50 |
| Income taxes paid | (1.50) |
| Net operating cash flow | 9.00 |
The signs follow the cash effect: more receivables usually means sales have not yet been collected, while more operating payables usually means some expenses have not yet been paid. Review composition before using these movements; asset-purchase creditors and borrowing balances do not belong in an ordinary operating-payables adjustment.
Step 2: investing and financing
Investing cash flow is ₹1.50 lakh received from the asset sale less ₹5 lakh paid for machinery, giving an outflow of ₹3.50 lakh. The sale proceeds are different from the ₹0.50 lakh accounting gain removed above.
Financing cash flow is ₹4 lakh of loan receipts less ₹2 lakh principal repayment and ₹1 lakh interest paid, giving an inflow of ₹1 lakh. If interest payable changed during the year, reconcile expense to actual interest paid before using that figure.
Step 3: complete the cash bridge
Net cash increase is ₹9 lakh − ₹3.50 lakh + ₹1 lakh = ₹6.50 lakh. With opening cash and cash equivalents of ₹2 lakh, closing cash and cash equivalents should be ₹8.50 lakh. Agree this with the underlying cash/bank working and the applicable cash-equivalent definition.
Errors to catch before export
- Showing depreciation as a cash payment.
- Using net PPE movement as machinery purchased.
- Recording only the disposal gain rather than sale proceeds.
- Including non-cash lease or asset transactions as cash flows.
- Confusing a tax provision with taxes paid.
Keep an adjustment file linking every material cash flow to records. A Schedule 3 financial builder can support preparation and presentation, but the final statement must explain actual cash movement. For assureOffice review, compare the generated cash bridge with this working before circulating the financials.
Reconcile movements before classifying them
Use ledger movements and supporting schedules to distinguish cash transactions from accounting adjustments. A new asset may have been acquired through a non-cash arrangement, while a loan closing balance may include an unpaid interest accrual. Neither movement can be interpreted safely from the opening and closing totals alone.
Mark each item as operating, investing, financing or non-cash under the applicable framework. Then trace cash receipts and payments to bank or cash records. Retain a separate list of excluded non-cash items so the reviewer can see that they were assessed, rather than simply overlooked in the cash-flow calculation.
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