Cash Flow from Operating Activities (Indirect Method)

The indirect method starts with profit before tax and adjusts for non-cash items and changes in working capital to arrive at cash generated from operations.

Step 1: Start with Profit Before Tax

Profit before tax = ₹1,50,000

Step 2: Add back non-cash expenses

Depreciation (included in Other Expenses) = ₹25,000

This is added back because depreciation reduces profit but does not involve any cash outflow.

Step 3: Adjust for changes in working capital

Working capital changes affect cash flow as follows:

• Trade Receivables decreased by ₹30,000: When receivables decrease, it means cash has been collected from debtors. This increases cash flow, so we add ₹30,000.

• Prepaid Expenses increased by ₹5,000: An increase in prepaid expenses means more cash has been paid in advance. This decreases cash available, so we subtract ₹5,000.

• Trade Payables increased by ₹15,000: When payables increase, it means we have purchased goods/services on credit without paying cash. This increases cash available, so we add ₹15,000. …

Concept: Cash Flow from Operating Activities (Indirect Method)

The Indirect Method starts with Profit before Tax from the Statement of Profit and Loss and adjusts it to arrive at actual cash generated from operations. Why? Because accounting profit is prepared on an accrual basis — it includes revenues earned (not necessarily received) and expenses incurred (not necessarily paid). Cash flow, however, reflects actual cash movements.

The Treatment: Adjustments to Profit before Tax

We make three categories of adjustments:

1. Add back non-cash expenses

Items like depreciation, amortization, and provisions reduce profit but involve no cash outflow. They must be added back.

2. Adjust for changes in Current Assets (excluding cash)

• Decrease in current assets (e.g., Trade Receivables, Prepaid Expenses) → cash has come in or not gone out → Add
• Increase in current assets → cash has gone out or not come in → Deduct

3. Adjust for changes in Current Liabilities

• Increase in current liabilities (e.g., Trade Payables, Outstanding Expenses) → cash has been retained (not paid out) → Add
• Decrease in current liabilities → cash has been paid out → Deduct

The logic: if receivables decrease, we collected more cash than the revenue recorded; if payables increase, we paid less cash than the expense recorded.

Solution: Cash Flow Statement (Operating Activities – Indirect Method)

Yamuna Limited

Cash Flow from Operating Activities

for the year ended March 31, 2017

Working Notes

W.N. 1: Non-cash Expense – Depreciation

Other Expenses given = ₹3,00,000

This includes Depreciation = ₹25,000

Depreciation is a non-cash charge (it reduces profit but no cash leaves the business). Hence, we add it back to Profit before Tax.

W.N. 2: Adjustment for Trade Receivables

Trade Receivables decreased by ₹30,000.

A decrease means cash was collected from debtors over and above the current year's credit sales recorded in Revenue from Operations. This is a cash inflow, so we add ₹30,000.

W.N. 3: Adjustment for Prepaid Expenses

Prepaid Expenses increased by ₹5,000.

An increase means more cash was paid in advance (an outflow) than the expense recognized in the P&L. We deduct ₹5,000.

W.N. 4: Adjustment for Trade Payables

Trade Payables increased by ₹15,000.

An increase means the company purchased goods/services on credit and has not yet paid the suppliers — cash is retained. This is a cash saving (inflow effect), so we add ₹15,000.

W.N. 5: Adjustment for Outstanding Expenses

Outstanding Expenses increased by ₹3,000. …