Class 12 Cash Flow Statement: Complete Concepts and Practice

Big picture

Profit is not cash. A company can report a healthy profit and still run short of cash, because its customers haven't paid yet, or it bought machinery, or it repaid a loan. The cash flow statement explains, in three sections, why the cash balance changed between two balance sheets:

1. Operating activities: cash generated by the main business.

2. Investing activities: cash spent on or received from long-term assets and investments.

3. Financing activities: cash raised from or returned to owners and lenders.

Operating + Investing + Financing = Net change in cash and cash equivalents. If your statement doesn't reconcile to the actual change in cash, something is misclassified or missing.

Learning goals

• Explain the objectives of a cash flow statement and the meaning of cash and cash equivalents.

• Classify any transaction as operating, investing or financing, for both non-financial and financial companies.

• Identify non-cash transactions that are left out.

• Find net profit before tax from the balance sheets.

• Calculate cash from operating activities by the indirect method.

• Reconstruct fixed asset, accumulated depreciation and provision for tax accounts to find hidden figures.

• Prepare a complete cash flow statement that reconciles.

Core ideas

1. Cash and cash equivalents

• Cash = cash in hand and demand deposits with banks.

• Cash equivalents = short-term, highly liquid investments that are readily convertible into a known amount of cash and carry an insignificant risk of change in value. An investment qualifies normally only if it has a maturity of three months or less from the date of acquisition (for example, a 90-day treasury bill or a short-term fixed deposit).

Movements between cash and cash equivalents (depositing cash in a 60-day deposit) are not cash flows, because the total does not change.

Objectives: to show how cash was generated and used, to help assess the company's ability to generate cash and meet obligations, and to support planning and comparison between periods and firms.

2. Classifying activities

Financial enterprises (banks, finance companies) are different: lending and investing are their main business, so interest and dividend received, and interest paid, are operating activities. Dividend paid stays a financing activity for every company.

Non-cash transactions are left out: issuing shares or debentures to a vendor for assets, converting debentures into shares, and issuing bonus shares do not involve cash, so they are not in the statement (they are disclosed in a note).

Short-term borrowings such as a bank overdraft or cash credit are treated as financing activities in CBSE problems.

3. Net profit before tax

Questions usually give only the balance of Surplus (Statement of Profit and Loss) in two balance sheets. The change in it is profit after appropriations, so add those back:

Net profit before tax = Closing Surplus - Opening Surplus
                      + Transfers to reserves during the year
                      + Dividend paid during the year (if charged to Surplus)
                      + Provision for tax made during the year

Example. Surplus rose from ₹1,00,000 to ₹1,60,000; ₹25,000 was transferred to General Reserve and tax of ₹40,000 was provided. Net profit before tax = 60,000 + 25,000 + 40,000 = ₹1,25,000.

4. Cash from operating activities: the indirect method

Start with net profit before tax and adjust in three steps.

Step 1: non-cash and non-operating items.

The result is operating profit before working capital changes.

Step 2: working capital changes.

Current investments that are cash equivalents and short-term borrowings are not part of these working capital changes.

Step 3: deduct income tax paid. The result is net cash from operating activities.

Example. Net profit before tax ₹2,00,000; depreciation ₹30,000; trade receivables increased by ₹20,000; inventory decreased by ₹10,000; trade payables increased by ₹5,000; tax paid ₹40,000. Cash from operations = 2,00,000 + 30,000 − 20,000 + 10,000 + 5,000 − 40,000 = ₹1,85,000.

5. Finding hidden figures: reconstructing accounts

Purchases and sales of fixed assets, depreciation and tax paid are often not given directly. Rebuild the account and find the balancing figure.

Fixed asset at cost

Opening balance + Purchases - Cost of asset sold = Closing balance

Accumulated depreciation

Opening balance + Depreciation for the year - Depreciation on asset sold = Closing balance

Provision for tax (when shown as a current liability)

Tax paid = Opening provision + Provision made this year - Closing provision

Sale of an asset. Book value = Cost − Accumulated depreciation on it. Cash received = Book value + Profit (or − Loss). The cash goes to investing activities; the profit or loss is adjusted in operating activities.

6. A complete cash flow problem

Balance Sheets of Neel Ltd (₹)

Additional information

1. Machinery costing ₹60,000 (accumulated depreciation ₹25,000) was sold for ₹30,000.

2. Investments costing ₹20,000 were sold for ₹26,000.

3. Tax of ₹45,000 was provided during the year.

4. Debentures of ₹50,000 were redeemed at par on 1 April 2024; interest on the remaining debentures was paid.

5. A dividend of ₹30,000 was paid out of Surplus, and dividend of ₹8,000 was received on investments.

Workings

Machinery at cost: 5,00,000 + Purchases - 60,000 = 6,40,000
  Purchases = 2,00,000
Accumulated depreciation: 1,00,000 + Dep - 25,000 = 1,30,000
  Depreciation for the year = 55,000
Loss on sale of machinery = (60,000 - 25,000) - 30,000 = 5,000
Profit on sale of investments = 26,000 - 20,000 = 6,000
Tax paid = 30,000 + 45,000 - 40,000 = 35,000
Interest on debentures = 1,50,000 x 10% = 15,000
Net profit before tax = (1,40,000 - 80,000) + 20,000 + 30,000 + 45,000 = 1,55,000

Cash Flow Statement for the year ended 31 March 2025

The closing figure matches the balance sheet, so the statement reconciles.

A reliable problem-solving routine

1. List the change in every balance sheet item. Mark each as operating (working capital), investing or financing.

2. Read the additional information and reconstruct fixed asset, depreciation, investment and tax accounts to find hidden figures.

3. Find net profit before tax by adding back appropriations to the change in Surplus.

4. Adjust for non-cash and non-operating items, then for working capital changes, then deduct tax paid.

5. Record investing and financing flows from the workings and the changes in long-term items.

6. Add the three sections and reconcile with the opening and closing cash and cash equivalents.

Connections that matter

• Financial statement analysis uses the same Schedule III statements; the cash flow statement is its fourth tool.

• Share capital and debentures produce the financing flows: issues, redemptions, interest and dividend.

• Class 11 depreciation explains the accumulated depreciation reconstruction.

Common mistakes

• Starting with the change in Surplus as if it were net profit before tax. Add back transfers to reserves, dividends and tax provided.

• Adding back depreciation and also showing it in investing activities. It is a non-cash item, adjusted once in operating activities.

• Showing the book value of an asset sold instead of the cash received in investing activities.

• Classifying interest paid as operating for a non-financial company. It is financing.

• Including non-cash transactions such as shares issued to vendors or bonus shares.

• Reversing working capital signs. An increase in a current asset is a deduction.

• Not reconciling to the closing cash and cash equivalents.

Revision checklist

• I can define cash equivalents and give examples.

• I can classify transactions for non-financial and financial companies.

• I can find net profit before tax from two balance sheets.

• I can prepare the operating section by the indirect method.

• I can reconstruct fixed asset, depreciation and tax accounts.

• I can prepare a full cash flow statement that reconciles.