Cash Flow Statement
The cash flow statement explains the movement in cash and cash equivalents only - it does not explain profit.
Three activities
Operating activities cover revenue-producing activities. Under the indirect method: start with net profit before tax; add back non-cash charges (depreciation, amortisation, loss on sale of assets); deduct non-operating incomes (profit on sale of assets, interest or dividend received); adjust for working capital changes; then deduct income tax paid. Investing activities: purchase and sale of property, plant and equipment, intangibles and investments; interest and dividends received (for a non-financing company). Financing activities: proceeds from issue of shares and debentures, borrowings and repayments, interest paid on borrowings, and dividends paid.
Working capital rule
An increase in a current asset such as debtors, inventory or prepaid expenses is deducted; an increase in a current liability such as creditors or outstanding expenses is added. Reverse the treatment for decreases. Cash and cash equivalents themselves are excluded from working capital changes.
Worked example
Profit before tax ₹5,00,000; depreciation ₹80,000; profit on sale of machinery ₹20,000; debtors increased by ₹60,000; creditors increased by ₹40,000; tax paid ₹1,20,000. Cash from operations = 5,00,000 + 80,000 − 20,000 − 60,000 + 40,000 − 1,20,000 = ₹4,20,000.
Traps
Showing depreciation as an inflow instead of an add-back; leaving interest paid on borrowings inside operating activities; forgetting to deduct tax paid; ignoring the profit or loss on sale of an asset when the sale proceeds appear under investing.