## Cash Flow from Operating Activities — Indirect Method

The indirect method starts with Profit Before Tax (PBT) and adjusts it to arrive at actual cash generated from operations. It never shows real cash receipts/payments — it reconciles book profit to cash.

### Standard Template

#	Item	Direction
1	Profit Before Tax (PBT)	Starting point
2	Add: Depreciation / Amortisation	+ (non-cash charge)
3	Add: Loss on sale of assets	+ (non-operating loss)
4	Less: Profit on sale of assets	− (non-operating gain)
5	Add: Finance cost (interest on borrowings)	+ (re-classified to financing)
6	Less: Interest / Dividend income	− (re-classified to investing)
7	Working Capital Adjustments
8	Increase in Trade Payables / other current liabilities	+
9	Decrease in Trade Payables / other current liabilities	−
10	Increase in Inventories / Trade Receivables / current assets	−
11	Decrease in Inventories / Trade Receivables / current assets	+
12	Less: Income Tax Paid (net of advance tax)	−
=	Cash Flow from Operating Activities

### Why each adjustment is made

Non-cash charges (Depreciation, Amortisation): PBT was reduced by these, but no cash left the business. Reverse them.

Finance cost added back: Interest will be shown as actually paid under Financing Activities. Adding it back here prevents double-counting.

Non-operating income deducted: Interest received, dividend received, profit on sale — these belong to Investing Activities. Remove them from operating profit.

Working capital changes: An increase in a liability (e.g., Trade Payables) means you consumed goods/services without paying — a cash saving, so add. An increase in an asset (e.g., Inventory) means cash went out that isn't in profit — so deduct.

Tax paid ≠ P&L tax charge: Always reconstruct actual cash paid using the combined Provision for Tax + Advance Tax ledger.

Worked example

### Example 1

Illustration 2 — Indirect Method (Partial)

Given: PBT = ₹40,000; Amortisation = ₹25,000; Interest Expense on Debentures = ₹75,000

```

A. Cash Flow from Operating Activities (Indirect)

PBT 40,000

Add: Amortisation 25,000

Add: Interest Expense on Debentures 75,000

---------

Cash from Operations (before WC) 1,40,000

```

Note: The ₹75,000 interest expense was a hidden adjustment — the rate was given, the amount was not stated in P&L. The amount was computed as ₹7,50,000 × 10% = ₹75,000.

### Example 2

Illustration 10 — Indirect Method (from same question)

Given: PBT = ₹710; Other income (non-operating) = ₹100; Depreciation = ₹100; Finance cost = ₹60; Increase in TP = ₹20; Increase in closing wages payable = ₹10; Increase in closing other expense payable = ₹10; Decrease in Inventory = ₹20; Increase in TR = ?

```

A. Cash Flow from Operating Activities (Indirect)

PBT 710

Less: Other income (non-operating) (100)

Add: Depreciation 100

Add: Finance cost 60

Working Capital Adjustments:

Add: Increase in TP 20

Add: Increase in wages payable 10

Add: Increase in other exp payable 10

Less: Decrease in Inventory (20)

Less: Increase in TR (??)

Less: Income tax paid

------

Cash Flow from Operating Activities ???

```

⚠️ Common exam mistakes

Adding profit on sale of assets instead of deducting (it is a non-operating GAIN — must be removed by deduction)
Using P&L tax charge directly as 'income tax paid' — always reconstruct via combined ledger of Provision for Tax and Advance Tax
Forgetting to add back amortisation of intangibles (goodwill, patents) — these are non-cash just like depreciation
Treating dividends declared (not yet paid) as cash outflow — only actually paid dividends appear
Including finance cost in operating activities without adding it back — it goes under financing activities as paid

Bare-Act text Paragraph 18(b), AS 3 · Accounting Standard 3 — Cash Flow Statements (ICAI) · click to expand

The indirect method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.

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