Mastering the Statement of Cash Flow: Indirect Method
What is a Statement of Cash Flow?
A Statement of Cash Flow is a financial statement that provides information on all the cash inflow (sources) and cash outflow (uses) activities of a company during a specific accounting period.
While the Profit & Loss Account tells you if a company was profitable, the Cash Flow Statement tells you if the company actually generated or spent cash. A company can be profitable but still go bankrupt if it runs out of cash.
The statement is divided into three main sections:
Operating Activities
Investing Activities
Financing Activities
1. Cash Flow from Operating Activities (CFO)
This section details the actual cash raised or spent by a company’s day-to-day business operations. This is the most important section as it shows if the core business is generating cash.
The most common way to calculate this is the Indirect Method, which is required by company law in India.
The Indirect Method
The Indirect Method does not track every single cash payment. Instead, it starts with the Net Income (from the P&L Account) and adjusts it to find the real cash.
The process is:
Step 1: Start with Net Income.
This is the “profit” from the P&L account.
Step 2: Add back all Non-Cash Expenses.
These are expenses that were subtracted to get Net Income, but didn’t actually involve spending cash.
Depreciation & Amortization: This is the most common example. It’s an “imaginary” charge.
Provisions (like Provision for Doubtful Debts)
One-time non-cash charges
Step 3: Adjust for changes in Working Capital (Current Assets & Liabilities).
Current Assets:
Add any Decrease in a Current Asset (e.g., you collected cash from Debtors, so Accounts Receivable decreased).
Subtract any Increase in a Current Asset (e.g., you spent cash to buy more Inventory, so Inventory increased).
Current Liabilities:
Add any Increase in a Current Liability (e.g., you bought goods on credit, so Accounts Payable increased, saving you cash).
Subtract any Decrease in a Current Liability (e.g., you paid off your Creditors, so Accounts Payable decreased).
The final number is the Net Cash Flow from Operating Activities.
2. Cash Flow from Investing Activities (CFI)
This section describes how the company spent or raised cash on new long-term investments. This section is usually negative because it shows the company is spending money to grow.
Common Activities:
Cash Outflow (Use): Purchase of new equipment, buildings, or land.
Cash Outflow (Use): Acquisition of another company.
Cash Inflow (Source): Sale of old equipment or buildings.
3. Cash Flow from Financing Activities (CFF)
This section reports the net cash that was raised from (or paid to) financial markets and owners.
Common Activities:
Cash Inflow (Source): Receiving new loans from a bank.
Cash Inflow (Source): Issuing new shares to investors.
Cash Outflow (Use): Repayment of a loan’s principal.
Cash Outflow (Use): Paying dividends to shareholders.
Putting It All Together: The Bottom Line
The statement combines the totals from all three sections to find the net change in cash for the period.
Net Cash from Operating Activities
+ / – Net Cash from Investing Activities
+ / – Net Cash from Financing Activities
= Net Increase (or Decrease) in Cash
This “Net Change in Cash” is then added to the Opening Cash Balance (from the beginning of the year) to get the Closing Cash Balance (at the end of the year). This final number must match the cash amount shown on the company’s Balance Sheet.
Why is the Cash Flow Statement So Important?
Analysts and investors watch this statement closely, especially for companies in financial trouble.
If a company’s cash on hand (plus operating cash flow) is not enough to pay its upcoming bills, auditors may issue a “going concern” warning.
This warning signals that the company may not have enough cash to survive and could be forced to seek bankruptcy protection.
Example: Sample Cash Flow Statement (Indirect Method)
Here is a simple example showing how the statement is structured.
Sample Business Plan
Statement of Cash Flow for the Month Ended [Date]
| Particulars | Amount (₹) | Amount (₹) |
| Cash Flow from Operating Activities | ||
| Net Income | 1,800 | |
| Adjustments for Non-Cash Items: | ||
| (Add) Depreciation | 600 | |
| Adjustments for Working Capital: | ||
| (Subtract) Increase in Accounts Receivable | (1,000) | |
| (Subtract) Increase in Supplies | (500) | |
| (Add) Increase in Accounts Payable | 600 | (300) |
| Net Cash Flow from Operating Activities | 2,100 | |
| Cash Flow from Investing Activities | ||
| Purchase of Land | (10,000) | |
| Purchase of Building | (25,000) | |
| Net Cash Flow used by Investing Activities | (35,000) | |
| Cash Flow from Financing Activities | ||
| Investment by Owner | 50,000 | |
| Owner’s Withdrawals (Dividends) | (600) | |
| Net Cash Flow provided by Financing Activities | 49,400 | |
| Net Increase (Decrease) in Cash | 16,500 | |
| Opening Cash Balance | (Assume 0) | |
| Closing Cash Balance | 16,500 |
(Note: The sample in the original text contained a calculation error. This version is corrected: 1,800 + 600 – 300 = 2,100. The final Net Increase is 2,100 – 35,000 + 49,400 = 16,500.)
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