## Indirect Method — Operating Activities
The indirect method starts from Profit Before Tax (PBT) and makes three layers of adjustments to arrive at operating cash flows.
> Investing and Financing sections are identical under both methods — only Operating Activities differ.
---
### Step 1 — Derive PBT (when only P&L closing balance is given)
If the Balance Sheet shows the closing P&L balance (not PBT directly):
```
Closing balance of P&L (per B/S)
Add: Transfers to Reserves (General Reserve, Capital Reserve, etc.)
Add: Appropriations charged to P&L (Proposed Dividend, Interim Dividend)
Add: Income Tax accrued (charged to P&L this year)
Add/Less: Remove effect of extraordinary items
= Profit Before Tax (PBT) — before extraordinary items
```
---
### Step 2 — Reverse Non-Cash Expenses
These reduced reported profit but involved no cash outflow:
| Item | Adjustment |
|---|---|
| Depreciation | + |
| Amortisation of intangibles / goodwill | + |
| Provisions created (bad debts, warranties) | + |
---
### Step 3 — Reverse Non-Operating Items
These affected PBT but belong to the Investing or Financing sections:
| Item | Adjustment |
|---|---|
| Profit on sale of PPE / investments | − |
| Loss on sale of PPE / investments | + |
| Interest income (goes to Investing) | − |
| Dividend income (goes to Investing) | − |
| Interest expense (goes to Financing) | + |
---
### Step 4 — Changes in Working Capital
Memory rule: Current assets and cash move in opposite directions; current liabilities and cash move in the same direction.
| Change | Cash Effect | Intuition |
|---|---|---|
| ↑ Current Asset (Inventory, Debtors, Prepaid Exp) | − | Cash locked up in the asset |
| ↓ Current Asset | + | Cash released |
| ↑ Current Liability (Creditors, Outstanding Exp) | + | Cash saved — not yet paid out |
| ↓ Current Liability | − | Cash paid out |
---
### Step 5 — Deduct Income Tax Paid (not accrued)
Use the Income Tax Payable T-account to find actual cash paid:
```
Income Tax Payable A/c
Dr: Tax paid (CIB — balancing figure) | Cr: Opening balance (b/d)
Dr: Closing balance (c/d) | Cr: Tax accrued this year (P&L charge)
```
`Tax paid = Opening balance + Tax accrued this year − Closing balance`
---
### Summary Template
```
Profit Before Tax (PBT)
+ Depreciation and non-cash expenses
− Non-cash income
+ Non-operating expenses (loss on sale)
− Non-operating income (profit on sale, interest income, dividend income)
± Changes in Working Capital
− Income Tax Paid (from T-account)
= Cash Flows from Operating Activities (before extraordinary items)
± Extraordinary items
= Net Cash Flows from Operating Activities
```