Cash Flow Statement Class 12 Notes: AS-3, Indirect Method and Worked Examples

Every company prepares three basic financial statements: the Position Statement (Balance Sheet), the Income Statement (Statement of Profit and Loss) and the Cash Flow Statement, which records the inflows and outflows of cash and cash equivalents over a period.

Under the Companies Act 2013, the Cash Flow Statement is prepared according to Accounting Standard-3 (AS-3), and a company’s financial statements are not ‘true and fair’ if the accounting standards are not followed (NCERT, p. 241).

This page is your revision pack for the chapter: what counts as cash, the operating/investing/financing classification and its exceptions, the indirect method with its sign rules, how to pull investing and financing figures out of two balance sheets, three worked examples with fresh numbers, common mistakes and a night-before recap.

Use it with your other Class 12 Accountancy notes and the wider Class 12 notes library.

These notes follow the 2026-27 session. Everything here is from Chapter 6 of the NCERT Class 12 Accountancy Part II textbook; the official copy is available on ncert.nic.in.

Why the Cash Flow Statement Matters

The Balance Sheet shows financial position on a date; the Income Statement shows the operating result of a period on an accrual basis. The Cash Flow Statement completes the trio by showing the period’s actual movement of cash, classified into operating, investing and financing activities (NCERT, p. 241).

Objective: to give users a basis for assessing the enterprise’s ability to generate cash and cash equivalents, and the timing and certainty of that generation (NCERT, p. 242).

Mandatory status: accounting standards are notified under Section 133 of the Companies Act 2013 and are mandatory; Section 2(40) of the Act includes the Cash Flow Statement, prepared as per AS-3, among the financial statements of a company (NCERT, p. 241).

Real-life application. A company can report healthy accounting profit yet run out of cash — customers may not pay on time, or stock may pile up unsold. Lenders, suppliers and investors therefore read operating cash flow to check whether reported profit is backed by actual cash.

A profitable company with negative operating cash flow can fail to pay dividends, and the cash flow statement exposes that problem immediately, while the Income Statement alone would not.

Cash and Cash Equivalents: What Counts as Cash

Under AS-3, cash means cash in hand and demand deposits with banks. Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and carry an insignificant risk of change in value. An investment normally qualifies only if it has a short maturity — three months or less from the date of acquisition (NCERT, p. 243).

• Shares are excluded from cash equivalents, unless acquired very close to a specific redemption date where the risk of the company failing to repay at maturity is insignificant — for example, preference shares bought shortly before redemption (NCERT, p. 243).
• Short-term marketable securities that can be liquidated immediately without considerable change in value do qualify.
• Cash flows are inflows and outflows arising from dealings in non-cash items — collection from trade receivables, payment to trade payables, payment to employees, receipt of dividend, interest payments (NCERT, p. 243).

Because cash equivalents are treated as part of ‘cash’, buying or selling them never appears in the cash flow statement. Parked surplus cash is moved into and out of cash equivalents as a cash-management decision, not as a cash flow (NCERT, p. 243).

The chapter’s Test your Understanding-I exercises (items 29-33) probe exactly these boundary items — overdraft, cash credit, short-term deposits, marketable securities and income-tax refunds — and the textbook gives the complete answer map on p. 286.

Operating, Investing and Financing: Classifying Every Cash Flow

AS-3 requires every cash flow to belong to one of three heads (NCERT, p. 243):

• Operating activities are the principal revenue-generating activities of the enterprise — its main activities, neither investing nor financing (NCERT, p. 244).
• Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents (NCERT, pp. 244-245).
• Financing activities change the size and composition of the owners’ capital (including preference share capital) and the borrowings of the enterprise (NCERT, pp. 245-246).

Two subtle AS-3 points change any simple classification (NCERT, p. 246):

• One transaction can split. When an instalment on a fixed asset bought on deferred payment includes both interest and loan, the interest element is financing and the loan element is investing.
• The same activity can classify differently for different enterprises. Purchase of shares is an operating activity for a share brokerage firm but an investing activity for other enterprises.

Personal-finance analogy. Your own money habits map cleanly onto the three heads:

Classification decision tree. For any item, ask in order:

1. Is it the enterprise’s main revenue-generating activity? Then it is operating. (Edge case: a share brokerage firm buying shares — buying and selling shares is its main activity, so the purchase is operating for the firm.)
2. Does it involve a long-term asset, or an investment outside the business? Then it is investing. (Edge case: a bank receiving interest — for a financial enterprise, interest received is operating, not investing.)
3. Does it change owners’ funds or borrowings? Then it is financing. (Edge case: dividend distribution tax — it travels with the dividend, under financing.)
4. Otherwise, is it a cash equivalent? If yes, it does not appear in the statement at all.

Quick classification check. Apply the tree to these ten items:

Interest, Dividend, Tax and Non-cash Deals: Special Rules

Extraordinary items. These are non-recurring events — loss due to theft, earthquake or flood. They are classified under the head they belong to (operating, investing or financing) and disclosed separately, so users can see their effect on present and future cash flows (NCERT, p. 247).

In the Oswal Mills illustration, a loss due to earthquake is added back to reach net profit before tax and then shown as an extraordinary deduction inside operating activities (NCERT, p. 269).

Interest and dividend. The nature of the enterprise decides the head (NCERT, p. 247):

Taxes on income and gains. AS-3 wants taxes separately disclosed and classified as operating unless they can be specifically identified with financing and investing activities (NCERT, p. 247):

Non-cash transactions. Investing and financing deals that use no cash are excluded from the statement — for example, acquiring machinery by issuing equity shares, or redeeming debentures by issuing shares. They are disclosed elsewhere in the financial statements (NCERT, p. 247).

Cash from Operating Activities by the Indirect Method

The operating figure needs special care because net profit is computed on accrual basis and includes items that involved no cash (depreciation, goodwill written off) and items that belong to investing or financing (interest, profit on sale of assets). All of these must be adjusted before profit can speak about cash (NCERT, p. 250).

AS-3 allows two presentations (NCERT, p. 249):

The six steps.

1. Start with Net Profit before Tax and Extraordinary Items.
2. Add back non-cash expenses: depreciation, goodwill or patents written off, provisions, deferred taxes (NCERT, p. 251).
3. Add back non-operating expenses such as interest and finance cost, and deduct non-operating incomes such as profit on sale of fixed assets, dividend received and interest received (NCERT, pp. 250-251). This gives Operating Profit before Working Capital Changes.
4. Adjust for working capital changes using the sign rule below (NCERT, p. 251).
5. Deduct income tax paid — the last adjustment before extraordinary items (NCERT, p. 252).
6. Adjust for extraordinary items to close with Net Cash from Operating Activities.

Memory device: ‘Assets rising or liabilities falling means cash is falling — deduct. Assets falling or liabilities rising means cash is rising — add.’

Previous year’s proposed dividend. Under AS-4, a proposed dividend stays in the Notes to Accounts as a contingent liability until shareholders approve it. Once approved in the current year, the previous year’s proposed dividend is paid from surplus — so it is added back to operating profit, and its payment is shown as an outflow under financing activities (NCERT, p. 249).

In the proforma, notice the starting point is ‘Net Profit before Tax and Extraordinary Items’, not the profit as per the Statement of Profit and Loss, and income tax paid is deducted at the end (NCERT, p. 252).

Investing and Financing Flows from Balance Sheet Changes

Operating flows start from the Statement of Profit and Loss; investing and financing flows start from two balance sheets. Compare opening and closing balances, then reconstruct the account to find the missing figure (NCERT, p. 258).

The sale proceeds themselves are usually given in the question; the profit or loss on sale goes to the Statement of Profit and Loss and re-enters cash flow only through its effect on net profit (Illustration 5 structure, NCERT, pp. 258-259).

Two presentation rules: investing and financing sections show gross receipts and gross payments separately — they are never netted (NCERT, p. 258) — and the whole exercise is the same compare-two-balance-sheets technique you already use in Accounting Ratios.

Assembling the Complete Statement: the Main-Heads Format

Exhibit 6.2 gives the skeleton every statement follows (NCERT, p. 248):

Three points to fix before your final answer (NCERT, p. 261):

• Verify the closing figure — it must equal the cash in hand, bank balance and cash equivalents shown on the balance sheet.
• Name the statement by its method — ‘indirect method cash flow statement’ when operating flows are worked out by the indirect method, and ‘direct method cash flow statement’ when they are worked out by the direct method. The textbook’s Illustration 10 presents both.
• When no method is specified, prefer the indirect method — the same choice most companies make in practice (NCERT, p. 261).

Key Terms Defined: A Revision Table

These are the chapter’s own introduced terms (NCERT, p. 275), reworded for quick revision:

Working Rules of Cash Flow Calculation

The chapter has no algebraic formulas, but its procedures reduce to six rules you can apply mechanically in any sum.

1. Cash from operations (indirect method). \[ \text{Cash from operations} = \text{Net profit before tax and extraordinary items} + \text{non-cash expenses} + \text{non-operating expenses} – \text{non-operating incomes} \pm \text{working capital changes} – \text{income tax paid} \]
2. Working capital sign table (NCERT, p. 251) — see the table below.
3. Tax paid from the provision account. \( \text{Tax paid} = \text{opening provision} + \text{provision made during the year} – \text{closing provision} \), adjusting any refund received (NCERT, p. 255).
4. Balancing figures. Purchases or sale of fixed assets come from the asset account; new loans raised or repaid come from the loan account (NCERT, p. 259).
5. Statement assembly. \( \text{Net increase in cash} = A + B + C \); \( \text{Closing cash} = \text{Opening cash} + \text{Net increase} \) (NCERT, p. 248).
6. Previous year’s proposed dividend. Add it back to operating profit; show the payment under financing (NCERT, p. 249).

Working capital sign table (Rule 2):

Worked Examples with Original Numbers

Example 1: Operating activities by the indirect method — Meridian Sports Ltd.

Example 2: Investing and financing flows from accounts — Vikram Textiles Ltd.

Method: reconstruct the asset and liability accounts (NCERT, p. 259), then tabulate the flows.

Given data:

• Machinery at cost: Rs 8,00,000 (opening), Rs 11,50,000 (closing).
• Accumulated depreciation: Rs 2,40,000 (opening), Rs 3,10,000 (closing); depreciation charged during the year Rs 1,60,000.
• A machine costing Rs 1,50,000 (accumulated depreciation Rs 90,000) was sold for Rs 45,000.

Step 1 — Machinery Account: Dr side is opening Rs.

8,00,000 plus purchases (balancing figure); Cr side is cost of machine sold Rs.

1,50,000 plus closing Rs.

11,50,000. \( 1,50,000 + 11,50,000 = 13,00,000 \), so purchases = \( 13,00,000 – 8,00,000 = \) Rs 5,00,000.

Step 2 — Accumulated Depreciation Account: opening Rs.

2,40,000 + depreciation Rs.

1,60,000 − accumulated depreciation on the sold machine Rs.

90,000 = closing Rs.

3,10,000. The account verifies the year’s depreciation charge.

Step 3 — Loss on sale: book value = \( 1,50,000 – 90,000 = 60,000 \); sold for Rs.

45,000, so the loss is Rs.

15,000 and goes to the Statement of Profit and Loss.

Step 4 — Investing flows: sale proceeds Rs.

45,000 inflow; purchase Rs.

5,00,000 outflow.

Step 5 — Financing flows: 12% debentures issued Rs.

2,00,000; bank loan repaid Rs.

1,50,000; interest on debentures paid Rs.

24,000; dividend paid Rs.

80,000.

Final answer: Net cash used in investing activities Rs 4,55,000; net cash used in financing activities Rs 54,000.

Example 3: A complete statement — Nova Retail Ltd.

Method: assemble A + B + C, add opening cash, and verify the closing figure.

Net increase = \( 1,25,000 – 75,000 + 15,000 = 65,000 \); closing balance = \( 40,000 + 65,000 = 1,05,000 \). Check that this matches the cash and cash equivalents figure on the balance sheet (NCERT, p. 261).

Your next question, answered: if Nova had bought the equipment partly by issuing shares, only the cash portion of the price would appear in the statement — non-cash investing transactions are excluded and disclosed elsewhere (NCERT, p. 247).

Common Mistakes Students Make in Cash Flow Sums

Misconception autopsy: students say ‘depreciation is added back because it is a source of cash’. The truth: depreciation is added back because it reduced profit without any cash leaving. It is not a source of cash — it undoes a non-cash charge. And that logic cannot be carried over to working capital items, where there is nothing to ‘undo’.

There, the change in the balance itself is the cash effect: debtors rising means cash has already left, so you deduct the rise directly.

How to Present a Complete Cash Flow Answer

The chapter closes with short descriptive questions, long descriptive questions and numerical problems (NCERT, pp. 276-285). Match your answer’s shape to the question type.

For a numerical problem, a complete answer has five parts:

1. State the method — indirect unless the question specifies otherwise (NCERT, p. 261).
2. Open the operating section with Net Profit before Tax and Extraordinary Items, and show how you got it — profit after tax + provision for tax made + previous year’s proposed dividend, exactly as in the working notes of Illustrations 7 and 8 (NCERT, pp. 264, 266).
3. Present the three sections labelled A, B and C with gross inflows and outflows; show negative amounts in brackets.
4. Reconcile the statement — net increase in cash and cash equivalents + opening balance = closing balance (NCERT, p. 261).
5. Support every derived figure with a working note or ledger account — Machinery Account, Accumulated Depreciation Account, Provision for Taxation Account, loan or debenture accounts — in the style of the solutions at pp. 259, 263 and 267.

For a classification question (for example, Test your Understanding-I, or short questions asking what constitutes operating activities for a hotel, a film production house, a financial enterprise, a media enterprise, a steel unit or a software business), name the activity and give a one-line reason from the definition.

For a long descriptive question (the procedure to prepare the statement, or the indirect method), structure the answer as: meaning and objectives of the cash flow statement → the three-fold classification → the indirect-method adjustment procedure → the proforma.

The full chapter, with every illustration, the complete answer maps and all exercises, is in the official NCERT Class 12 Accountancy Part II textbook (Chapter 6, Cash Flow Statement).

Revision Summary: The Night-Before Recap

The four-step plan.

1. Classify every flow as operating, investing or financing (cash equivalents never appear).
2. Compute operating cash flow by the indirect method: profit → non-cash and non-operating adjustments → working capital changes → income tax → extraordinary items.
3. Compute investing and financing flows from balance-sheet changes using T-accounts.
4. Assemble A + B + C, add opening cash, arrive at closing cash and verify it against the balance sheet.

Sign-rule mnemonic: Assets rising or liabilities falling — deduct. Assets falling or liabilities rising — add.

Five most forgotten adjustments to watch for in cash flow sums:

• Previous year’s proposed dividend — add back to operating, pay under financing (NCERT, p. 249).
• Tax paid — open a Provision for Taxation Account; never use the provision balance (NCERT, p. 255).
• Profit or loss on sale of assets — deduct profit, add loss, in the operating adjustments.
• Prepaid and outstanding expense adjustments — they move with the working capital signs.
• Marketable securities as cash equivalents — their purchases and sales are not shown.

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Frequently Asked Questions

Why is depreciation added back to net profit while computing cash from operations?

Because depreciation reduced net profit without any cash going out of the business. Adding it back removes a non-cash charge so that the profit figure moves closer to cash; it is not being treated as a source of cash (NCERT, pp. 250-251).

Is a bank overdraft a cash equivalent, and where is it shown in the cash flow statement?

No. A bank overdraft is a short-term borrowing from the bank, not a liquid investment, so it is not a cash equivalent. The NCERT answer map for Test your Understanding-I classifies it under financing activities (NCERT, p. 286).

Why is the previous year’s proposed dividend added back to operating profit and shown under financing activities?

Because in the current year it is a payment, not an expense of current operations. The dividend was proposed last year, stays a contingent liability until shareholders approve it (AS-4), and is then paid out of surplus in the current year. So it is added back to operating profit, and the payment is reported as a financing outflow (NCERT, p. 249).

When is interest received classified as operating instead of investing?

When the enterprise is a financial enterprise whose main business is lending and borrowing — there, interest received is a principal revenue-generating activity, hence operating. For a non-financial enterprise, interest received is an investing inflow (NCERT, p. 247).

How do I calculate income tax paid when only the provision for taxation balance is given?

Prepare the Provision for Taxation Account: opening balance + provision made during the year − closing balance gives tax paid, with any refund adjusted separately. The textbook demonstrates this account in Illustration 3 (NCERT, p. 255).

What is the difference between the direct and indirect methods of presenting operating cash flows?

The direct method discloses major classes of gross cash receipts and gross cash payments; the indirect method starts with net profit before tax and extraordinary items and adjusts it for non-cash items, deferrals or accruals of operating receipts and payments, and items of income or expense linked to investing or financing flows (NCERT, p. 249).

Both give the same operating cash figure (NCERT, p. 252), and companies mostly use the indirect method.

Reference: NCERT Class 12 Accountancy textbook, chapter Cash Flow Statement.

Official source: download the NCERT textbook free from ncert.nic.in.