# Cash Flow Statement — AS 3: Overview and Classification

## Purpose

A Cash Flow Statement explains the change in Cash and Cash Equivalents (CCE) during a period by categorising all cash movements into three activities. It bridges the P&L and Balance Sheet by answering: where did cash come from, and where did it go?

## Key Definitions

Term	Meaning
Cash	Notes, coins, and demand deposits (e.g., current account balance)
Cash Equivalents (CE)	Short-term (≤ 3 months maturity), highly liquid investments (a) readily convertible to a known cash amount and (b) subject to insignificant risk of value change. Examples: Treasury bills, commercial paper
Cash & Cash Equivalents (CCE)	Cash + CE combined — this is the figure the statement explains
Cash Flows	All inflows and outflows of CCE during the period

## Three Sections

Section	Economic Nature	Typical Items
A. Operating	Principal revenue-generating activities	Cash from customers, payments to suppliers, wages, rent, income tax
B. Investing	Acquisition and disposal of long-term assets and investments	PPE purchase/sale, investment purchase/sale, interest/dividend received
C. Financing	Changes in size and composition of equity and borrowings	Share issue/buyback, loans, debentures, interest paid, dividends paid

## Direct Method vs Indirect Method

This choice applies only to Section A (Operating Activities). Sections B and C have a single fixed format.

	Direct Method	Indirect Method
Starting point	Gross cash receipts and payments	Net Profit Before Tax (PBT)
Approach	List each cash inflow/outflow directly	Adjust PBT by reversing non-cash and non-operating items
Result	Identical	Identical

## Bottom Reconciliation Format

```

Net Cash from Operating Activities (A) xxx

Net Cash from Investing Activities (B) xxx

Net Cash from Financing Activities (C) xxx

──────

Net Increase / (Decrease) in CCE xxx

Opening Cash and Cash Equivalents xxx

──────

Closing Cash and Cash Equivalents xxx ← Must equal Balance Sheet CCE

```

## Classification Tip

When in doubt about which section an item belongs to:

Does it relate to day-to-day trading operations? → Operating
Does it involve buying or selling a long-term asset or investment? → Investing
Does it change the company's capital structure or borrowings? → Financing

Worked example

### Example 1

## Classification Exercise

Classify each item into Operating (O), Investing (I), or Financing (F):

Item	Section	Reason
Cash received from customers	O	Core revenue activity
Purchase of machinery	I	Long-term asset acquisition
Salary paid	O	Operating expense
Issue of debentures	F	Changes borrowings
Dividend received	I	Return on long-term investment
Dividend paid	F	Return to equity providers
Income tax paid	O	Directly linked to operating profit
Loan given to subsidiary	I	Long-term capital deployment
Redemption of preference shares	F	Changes capital structure
Rent received on investment property	I	Return on investment property

⚠️ Common exam mistakes

Confusing 'dividend received' (Investing — return on investment) with 'dividend paid' (Financing — return to shareholders).
Applying the Direct/Indirect method choice to all three sections — only Operating Activities have two methods; Investing and Financing are always the same.
Treating income tax paid as Financing because it involves money leaving the firm — income tax is always classified under Operating Activities.
Forgetting to verify that Closing CCE per the Cash Flow Statement equals the Cash and Bank balance in the Balance Sheet.

Bare-Act text Para 3, 6, 10, 19, 23 · AS 3 — Cash Flow Statements (ICAI) · click to expand

Para 3 — Definitions: Cash: Cash comprises cash on hand and demand deposits. Cash equivalents: Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Para 6: Cash flows are inflows and outflows of cash and cash equivalents. Para 10 (Operating Activities): Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the enterprise. Para 19 (Investing Activities): Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Para 23 (Financing Activities): Financing activities are activities that result in changes in the size and composition of the owners' capital (including preference share capital in the case of a company) and borrowings of the enterprise.

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Cash Flow Statement - AS 3 Overview and Classification

Worked example

⚠️ Common exam mistakes