## Indirect Method: From PBT to Cash Flow from Operations
Under the indirect method, always start with Profit Before Tax (PBT) — not PAT, not the reserve balance — and adjust to arrive at cash generated from operations.
### Why PBT and not PAT?
Tax paid is deducted separately after working capital adjustments. Starting from PBT avoids double-counting the tax charge.
### Step 1: Reconstruct PBT from P&L / Reserve Account
If the question gives opening/closing balances of P&L and Reserves instead of PBT directly, build PBT upward:
| Item | Direction |
|---|---|
| Closing P&L balance (or net P&L for the year) | Base |
| Add: Transfer to General Reserve (current year) | + |
| Add: Dividend declared in current year | + |
| Add: Provision for Tax (current year charge) | + |
| = PBT |
> Key rule: If no dividend was declared in the current year (only a prior-year dividend was paid), do NOT add dividend back here. Nothing to reverse — it was never charged to this year's P&L/Reserves.
### Step 2: Adjust for Non-Cash and Non-Operating Items
Add back (non-cash charges):
- Depreciation
- Amortisation
- Provision increases already added in Step 1
Deduct (non-operating income — will reappear under Investing Activities as full proceeds):
- Profit on sale of fixed assets or investments
Add back (non-operating losses — full proceeds still go to Investing Activities):
- Loss on sale of fixed assets
### Step 3: Working Capital Adjustments
| Change | Cash Effect |
|---|---|
| Increase in current assets (inventory, debtors) | Negative — cash used |
| Decrease in current assets | Positive — cash released |
| Increase in current liabilities (creditors, expenses payable) | Positive — cash conserved |
| Decrease in current liabilities | Negative — cash paid out |
### Step 4: Deduct Income Tax Paid
Do not use the P&L charge. Use the Provision for Tax ledger to find actual cash paid:
Tax paid = Opening provision + Current year charge − Closing provision
### Result: Cash Flow from Operating Activities