# Cash Flow from Operating Activities — Indirect Method

## Core Logic

Start with Profit Before Tax (PBT) and strip out every item that is either (a) non-cash (depreciation, provisions — charged to P&L but no cash moved) or (b) non-operating (profit/loss on asset sales, interest received, dividends received — these belong in Investing/Financing sections). After stripping, adjust for working capital changes and deduct actual taxes paid.

## Step 0 — Reconstruct PBT (when only Balance Sheet is given)

If PBT is not directly stated and only the closing P&L balance appears in the Balance Sheet:

```

Closing P&L balance (from Balance Sheet) xx

+ Transfer to Reserves during the year xx

+ Dividends declared / proposed xx

+ Income Tax charged to P&L during the year xx

────────────────────────────────────────────────────

= Profit Before Tax (PBT) xx

```

## Full Indirect Method Format

```

Profit Before Tax (PBT) xx

──────

Add: Non-Cash Expenses

Depreciation — Buildings xx

Depreciation — Furniture / Plant / Cars xx

Amortisation, write-offs xx

Provisions created xx

Less: Non-Cash Income (xx)

Add: Non-Operating Expenses [will appear in Investing/Financing]

Loss on sale of fixed assets xx

Loss on sale of investments xx

Less: Non-Operating Income [will appear in Investing/Financing]

Profit on sale of fixed assets (xx)

Profit on sale of investments (xx)

Interest received (classified under Investing) (xx)

Dividend received (classified under Investing) (xx)

──────

Operating Profit (before Working Capital changes) xx

± Changes in Working Capital:

+ Increase in Current Liabilities xx

− Decrease in Current Liabilities (xx)

− Increase in Current Assets (xx)

+ Decrease in Current Assets xx

──────

Less: Income Tax Paid (actual cash outflow) (xx)

──────

CF from Operating Activities (before extraordinary) xx

± Extraordinary items ±xx

──────────────────────────────────────────────────────────────

Net Cash Flow from Operating Activities (A) xx

```

## Working Capital Change Rules

Item Type	Change	Effect on Cash	Logic
Current Asset (Inventory, Debtors, Prepaid)	↑ Increase	− Deduct	Cash was locked into the asset
Current Asset	↓ Decrease	+ Add	Asset was converted back to cash
Current Liability (Creditors, Outstanding exp)	↑ Increase	+ Add	Payment deferred = cash retained
Current Liability	↓ Decrease	− Deduct	Cash was used to settle the liability

Memory aid: Current assets are the opposite of cash. Current liabilities move with cash.

## Deriving Actual Tax Paid

Use the Income Tax Payable T-account:

```

Income Tax Payable A/c

──────────────────────────────────────────────────

Cash paid (balancing figure) → | ← Opening balance

Closing balance → | ← Tax accrued in P&L

```

Formula: Tax Paid = Opening Payable + Tax Accrued in P&L − Closing Payable

Worked example

### Example 1

## Q2 — Operating Activities Section (Indirect Method)

Data:

Profit Before Tax: ₹8,000
Depreciation: Building ₹1,000 | Furniture ₹2,000 | Cars ₹5,000
Profit on sale of Cars: ₹1,400 (non-operating income — deduct)
Profit on sale of Investments: ₹8,000 (non-operating income — deduct)
Working capital changes: Trade Payables +₹3,000 | Inventory +₹6,000 | Trade Receivables +₹2,000
Tax Payable: Opening ₹2,000 | Accrued in P&L ₹3,000 | Closing ₹3,000

Tax Paid Calculation:

```

Opening Tax Payable 2,000

+ Tax accrued in P&L 3,000

− Closing Tax Payable (3,000)

─────────────────────────────

Actual Tax Paid 2,000

```

Operating Activities Section:

Item	₹
Profit Before Tax	8,000
Add: Depreciation — Building	1,000
Add: Depreciation — Furniture	2,000
Add: Depreciation — Cars	5,000
Less: Profit on sale of Cars	(1,400)
Less: Profit on sale of Investments	(8,000)
Subtotal	6,600
Add: Increase in Trade Payables (liability ↑ → +)	3,000
Less: Increase in Inventory (asset ↑ → −)	(6,000)
Less: Increase in Trade Receivables (asset ↑ → −)	(2,000)
Less: Income Tax Paid	(2,000)
Net Cash from Operating Activities (A)	(400)

⚠️ Common exam mistakes

Starting from Profit After Tax (PAT) instead of Profit Before Tax (PBT) — tax is adjusted separately as actual cash paid, so PBT must be the starting point.
Getting working capital direction wrong: students often add increases in debtors (current asset) when they should deduct. Remember: asset ↑ means cash was used up, so deduct.
Treating depreciation as a cash inflow — it is not cash; it is simply added back because it was charged to P&L (reducing PBT) without any cash outflow.
Using accrued tax (from P&L) as the tax payment figure instead of actual cash paid — always use the Tax Payable T-account to find cash paid.
Including interest paid or dividends paid in Operating Activities under the Indirect Method when the company classifies these under Financing — they must be reversed out of PBT and placed in the Financing section.

Bare-Act text Para 18 and Para 20 · AS 3 — Cash Flow Statements (ICAI) · click to expand

Para 18 — Methods for Reporting Operating Activities: An enterprise should report cash flows from operating activities using either: (a) the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or (b) 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. Para 20 (Indirect Method guidance): In the indirect method, the net cash flow from operating activities is determined by adjusting net profit or loss for the effects of: (a) changes during the period in inventories and operating receivables and payables; (b) non-cash items such as depreciation, provisions, deferred taxes, unrealised foreign exchange gains and losses; and (c) all other items for which the cash effects are investing or financing cash flows.

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Cash Flow Statement - Indirect Method (Operating Activities)

Worked example

⚠️ Common exam mistakes