The cash flow statement, prepared

Chapter 6 of the Company analysis subject read this statement. Here it is built — and building it is the single most effective way to understand what accrual accounting has done to the income statement, because the preparation is literally the list of accruals being removed.

What it reports

Ind AS 7 provides information about the historical changes in cash and cash equivalents during the period, from operating, investing and financing activities.

Cash is cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments readily convertible to known amounts of cash and subject to an insignificant risk of changes in value.

That last phrase matters: a volatile short-term investment is not a cash equivalent, however liquid. Liquidity is not enough — the amount has to be knowable.

The three categories

Operating — the cash effects of the transactions producing profit. The one that matters most, because it is the only recurring source.

Investing — acquiring and disposing of long-term assets and other investments. Capital expenditure lives here.

Financing — changes in the size and composition of equity and borrowings. Dividends, share issues, loans raised and repaid.

The classification decisions are themselves worth watching, which is the end of this chapter.

Building it: the indirect method

Start at profit and undo the accruals, in a fixed order.

Step 1 — add back non-cash charges. Depreciation and amortisation (chapter 8), impairment, provisions charged but not paid, deferred tax (chapter 11). These reduced profit without moving cash.

Step 2 — remove items belonging to another category. Interest and tax are handled per the entity's policy; gains or losses on asset disposals are removed from operating because the proceeds appear in investing. Leaving a disposal gain in operating would make a one-off sale look like trading performance.

Step 3 — adjust for working-capital movements. The step that does the real work. One rule covers it:

An increase in an asset consumes cash. An increase in a liability provides it.

Movement	Effect on cash
Receivables up	Negative — sales recognised, not collected
Inventory up	Negative — cash converted into stock
Payables up	Positive — suppliers are funding you
Receivables down	Positive
Payables down	Negative

Working the problem

	₹ crore
Profit	100
Add depreciation	+30
Receivables up	−50
Inventory up	−20
Payables up	+15
Cash from operations	75

Profit of ₹100 crore, cash of ₹75 crore. The ₹25 crore gap is not a mystery and not necessarily a problem: ₹30 crore of the profit was a non-cash charge added back, and ₹55 crore of cash went into working capital as the business grew.

This is chapter 5's point made arithmetic. Growth consumes cash through receivables and inventory, and the income statement reports none of it.

Why the indirect method is the useful one

The direct method lists actual cash receipts and payments and is arguably clearer for a lay reader. Almost nobody uses it.

The indirect method is more informative for analysis precisely because it shows the reconciliation. The gap between profit and operating cash, item by item, is the earnings-quality question answered in a table — which is why chapter 14 of the Company analysis subject starts here.

Where judgement remains

Less than in the income statement, but not none:

Classification. Whether an outflow is operating or investing changes operating cash flow without changing cash. Capitalised development costs are the standard case: expensed, they reduce operating cash; capitalised, they move to investing and operating cash looks better.

Interest and dividends. Ind AS permits choices about where these sit. A company classifying interest paid as financing reports higher operating cash flow than one classifying it as operating.

What counts as a cash equivalent. The definition is tight, but the boundary is a judgement.

So the statement is harder to manipulate than profit, not impossible. The reliable check is multi-year: cumulative operating cash flow against cumulative profit over five years. Classification choices move things between lines in a year; they cannot make cash appear over five.

The point

Ind AS 7 reports movements in cash and cash equivalents across operating, investing and financing. The indirect method starts at profit, adds back non-cash charges, removes items belonging elsewhere, and adjusts for working capital under one rule — asset up consumes cash, liability up provides it. The resulting gap between profit and operating cash is the list of accruals, itemised, which is why building the statement teaches accrual accounting better than reading it does.