Think of AS 3 as a financial CCTV camera — it shows you exactly where cash came in and where it went out during the year. The Profit & Loss account can be manipulated with accruals and depreciation, but cash doesn't lie. That's why banks, investors, and examiners love it.
AS 3 requires you to split all cash movements into three buckets: Operating Activities (day-to-day business — cash from customers, cash to suppliers, salaries), Investing Activities (buying/selling long-term assets — machinery, investments, loans given), and Financing Activities (how the business is funded — share capital raised, loans taken or repaid, dividends paid). A simple thumb rule: if it touches the P&L regularly → Operating; if it touches fixed assets or long-term investments → Investing; if it touches the liability/equity side of the balance sheet → Financing.
For Operating Activities, AS 3 gives you two methods. The Direct Method lists actual cash receipts and payments (cash collected from customers, cash paid to suppliers). The Indirect Method starts with Net Profit Before Tax and adjusts for non-cash items (add back depreciation, amortisation), working capital changes (increase in debtors = cash outflow; increase in creditors = cash inflow), and then taxes paid. ICAI strongly prefers the Indirect Method in exams — almost every exam paper uses it. One critical rule: interest paid and dividends paid by a company are classified under Financing Activities; interest and dividends received go under Investing Activities (for a non-finance company). Also remember — cash equivalents are short-term, highly liquid investments with original maturity of 3 months or less (e.g., treasury bills, commercial paper). Bank overdraft repayable on demand is treated as part of cash and cash equivalents. Non-cash transactions (e.g., purchase of asset by issuing shares, conversion of debt to equity) are excluded from the Cash Flow Statement but disclosed separately in notes.