## Indirect Method — Cash Flow from Operating Activities

Under the indirect method, you start with Profit Before Tax (PBT) and work backwards by:

1. Adding back non-cash charges and non-operating losses that were debited to P&L

2. Deducting non-cash credits and non-operating gains that were credited to P&L

3. Adjusting for changes in working capital

4. Deducting income tax actually paid (not the provision)

### Step-by-step layout

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A. Cash Flow from Operating Activities

Net Profit before tax (PBT) ×××

Adjustments for non-cash / non-operating items:

Add back (items debited to P&L that are not cash outflows OR relate to other activities):

+ Depreciation on fixed assets ×××

+ Loss on sale of fixed assets ×××

+ Loss on write-off of fixed assets ×××

+ Premium on redemption of Pref. shares / Deb. ×××

+ Interest expense on Debentures ×××

+ Goodwill amortisation ×××

+ Provision for tax (created in P&L) ×××

Deduct (items credited to P&L that are not cash inflows OR relate to other activities):

– Profit on sale of fixed assets / investments (×××)

– Interest / dividend income (×××)

– Dividend declared (charged to P&L) (×××)

Operating profit before working-capital changes ×××

Changes in Working Capital:

+ Decrease in current assets (or increase in curr. liabilities) ×××

– Increase in current assets (or decrease in curr. liabilities) (×××)

Cash generated from operations ×××

– Income tax paid (actual cash paid) (×××)

Net Cash from Operating Activities [A] ×××

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### Key distinctions

Item	Treatment	Reason
Depreciation	Add back	Non-cash charge — no cash leaves the business
Loss on sale of plant	Add back	Non-operating; cash receipt captured in investing activities
Profit on sale of plant	Deduct	Non-operating; cash receipt captured in investing activities
Premium on redemption of Pref/Deb	Add back	Financing activity; if already charged in PBT, reverse it
Interest on Debentures	Add back	Financing activity; actual payment shown in financing section
Interest income on investments	Deduct	Investing activity; actual receipt shown in investing section
Provision for tax	Add back	Non-cash; actual tax paid is deducted separately
Dividend declared	Add back	Financing activity (actual payment shown in financing section)

> Rule of thumb: Ask "Is this item (a) non-cash? or (b) related to investing/financing?" If yes to either, reverse it from PBT.

Worked example

### Example 1

Illustration 19 (CDR) — Indirect Method

A. Cash Flow from Operating Activities

Item	₹
P&L Reserve (transferred from prior year)	76,000
General Reserve (transferred in CY)	1,60,000
Less: Dividend declared in CY	(1,20,000)
Less: Dividend declared in CI	—
Add: Provision for tax (in P&L)	3,40,000
Profit Before Tax (PBT)	5,76,000
Add: Loss on sale of Plant	20,000
Add: Loss on plant written off	16,000
Add: Depreciation on plant	3,60,000
Less: Profit on sale of Investment	(40,000)
Add: Premium on redemption of Pref shares	6,000
Add: Premium on redemption of Debentures	6,000
Add: Interest on Debentures (hidden adj.)	36,000
Operating profit before WC changes	9,80,000
Add: Increase in Current Liabilities	40,000
Add: Decrease in Current Assets	16,000
Cash generated from operations	11,34,000
Less: Income Tax paid	(3,60,000)
Net Cash from Operating Activities [A]	6,44,000

Note on premium on redemption: The premium was already charged to P&L while calculating PBT. Since it is a non-operating (financing) item, it must be added back to reverse its impact.

### Example 2

Question 9 — Indirect Method

A. Cash Flow from Operating Activities

Item	₹
P&L Reserve (CY transfer)	30,000
General Reserve (CY transfer)	41,000
Less: Dividend declared in CY	(5,000)
Add: Provision for tax (P&L)	16,000
Profit Before Tax (PBT)	92,000
Add: Depreciation on vehicles	2,200
Add: Loss on sale of vehicles	800
Less: Profit on sale of land	(25,000)
Add: Depreciation on furniture	5,000
Add: Interest expense on Debentures	12,000
Less: Profit on sale of investments	(8,000)
Less: Interest income on investments	(6,500)
Add: Goodwill amortisation	13,000
Operating profit before WC changes	85,500
Less: Increase in inventory	(8,000)
Add: Decrease in bills receivable	3,650
Less: Increase in trade receivables	(6,000)
Add: Increase in bills payable	2,000
Add: Increase in trade payables	4,000
Add: Increase in outstanding expenses	1,500
Cash generated from operations	82,650
Less: Income Tax paid	(8,300)
Net Cash from Operating Activities [A]	74,350

⚠️ Common exam mistakes

Using 'provision for tax created' (P&L charge) instead of 'income tax actually paid in cash' for the deduction — the provision is added back to PBT, and only the cash actually paid is deducted.
Forgetting to add back interest on debentures when it is a hidden adjustment — if no separate line item appears, reconstruct the Debenture T-account to find the interest figure.
Not reversing premium on redemption of preference shares/debentures from PBT — if the premium was charged to P&L (included in PBT), it must be added back as it is a financing activity.
Treating 'dividend declared' as a working-capital adjustment instead of reversing it from PBT as a financing activity.
Netting cash from investing with operating — profit/loss on asset disposal must be reversed from PBT, and the full sale proceeds are shown separately under investing activities.
Using the balance-sheet change in 'provision for tax' as a WC change rather than as the adjustment to PBT — provision for tax is not a trade payable; it is a separate add-back.

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

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.

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Cash Flow Statement (AS 3) — Indirect Method: Framework for Operating Activities

Worked example

⚠️ Common exam mistakes