## Cash Flow from Operating Activities: Indirect Method

The indirect method starts with Profit Before Tax (PBT) and reconciles it to net cash from operations by making three categories of adjustments.

### Step-by-Step Framework

```

PBT (from P&L) ×××

ADD (Non-cash charges debited to P&L):

+ Depreciation / Amortisation ×××

+ Provision for bad debts ×××

+ Loss on sale of assets ×××

LESS (Non-cash credits in P&L):

− Profit on sale of assets ×××

ADD (Non-operating expenses — finance):

+ Interest expense (on borrowings) ×××

LESS (Non-operating income):

− Interest income ×××

− Dividend income ×××

= Operating Profit before Working Capital Changes

Adjust Working Capital changes (Current Assets ↑ = use of cash; Liabilities ↑ = source):

± Changes in Trade Receivables ×××

± Changes in Inventories ×××

± Changes in Trade Payables ×××

± Changes in Outstanding Expenses ×××

± Changes in Advance Tax / Provisions ×××

= Cash generated from Operations

− Income Tax Paid (net of advance tax) ×××

= Net Cash from Operating Activities ×××

```

### Key Rules

Loss on sale: Add back (it was debited to P&L but the sale proceeds appear in Investing activities).
Profit on sale: Deduct (credited to P&L but proceeds in Investing activities).
Interest expense: Always add back here; actual cash paid appears in Financing activities.
Interest/Dividend income: Always deduct here; cash received appears in Investing activities.
Increase in current asset (e.g., TR, Inventory) → deduct (cash used to fund it).
Decrease in current asset → add (cash released).
Increase in current liability (e.g., TP, outstanding wages) → add (creditors funded you).
Decrease in current liability → deduct (you paid them).

Worked example

### Example 1

Illustration (Indirect Method — with Amortisation and Debenture Interest)

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

```

A. Cash Flow from Operating Activities

PBT 40,000

Add: Amortisation (non-cash) 25,000

Add: Interest Exp on Debentures 75,000

Operating Profit (before WC changes) 1,40,000

± Working Capital Adjustments ...

Less: Income Tax Paid ...

Net CF from Operating Activities ×××

```

### Example 2

Illustration 10 — Indirect Method (reconciling with direct method)

Given: PBT = ₹710; Other income (non-operating) = ₹100; Depreciation = ₹100; Finance cost = ₹60

WC changes: TP +20, Closing wages +10, Closing other expenses +10, Inventory −20, TR change ×××

```

PBT 710

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

Add: Depreciation 100

Add: Finance cost 60

770

Changes in Working Capital:

Increase in TP 20

Increase in Outstanding wages 10

Increase in Outstanding expenses 10

Decrease in Inventory 20

Increase/(Decrease) in TR ×××

Less: Income Tax Paid ×××

Net CF from Operating Activities ×××

```

> Tip: When a question asks you to solve by BOTH methods, treat them as two separate independent questions. Do NOT try to interlink the two — they should arrive at the same Net CF but via completely different routes.

⚠️ Common exam mistakes

Adding interest income instead of deducting it — interest income is non-operating; it must be removed from operating profit.
Forgetting to deduct profit on sale (or add back loss on sale) — the full sale proceeds are shown in Investing activities, so the P&L effect must be reversed here.
Treating provision for tax as a WC change rather than adjusting income tax paid separately at the end.
Confusing direction of WC changes: an increase in Trade Receivables is a DEDUCTION (more cash tied up), not an addition.
Trying to cross-check or interlink both methods within the same solution — solve them independently when both are required.

Bare-Act text Paragraph 18 · AS 3 — Cash Flow Statements · click to expand

An entity shall 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 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 from Operating Activities — Indirect Method

Worked example

⚠️ Common exam mistakes