AccountancyCBSE Class 12 · Cash Flow Statement

Classification of Activities in a Cash Flow Statement (AS 3): Class 12 Rules and Cases

Updated 15 October 2026 · Fact-checked

AS 3 classifies cash flows into three activities. Operating activities are the principal revenue-producing activities; investing activities are buying and selling long-term assets and investments that are not cash equivalents; financing activities change the size or composition of owners' capital and borrowings. Interest and dividends are classified differently for financial and non-financial enterprises.

Sort every cash flow into operating, investing or financing; together they give the net change in cash and cash equivalents.

Illustration drawn for QuestionBuddy.

Understand Classification of Cash Flow Activities

Cash and cash equivalents. Cash = cash in hand and demand deposits with banks. Cash equivalents = short-term, highly liquid investments readily convertible into known amounts of cash with insignificant risk of change in value, normally with a maturity of 3 months or less from the date of acquisition (for example, short-term treasury bills). Moving money between cash and cash equivalents is not a cash flow. CBSE: current investments are taken as marketable securities (cash equivalents) unless otherwise specified; bank overdraft and cash credit are treated as short-term borrowings (financing).

1. Operating activities (principal revenue-producing activities):

cash receipts from sale of goods and services, royalties, fees and commission;
cash payments to suppliers, employees and for expenses;
income tax paid (unless specifically identified with investing or financing).

2. Investing activities (long-term assets and investments not in cash equivalents):

purchase or sale of fixed assets (PPE, intangibles such as goodwill or patents);
purchase or sale of shares, debentures and other long-term investments;
loans and advances made to others (non-financial company) and their repayment;
interest and dividends received by a non-financial company.

3. Financing activities (owners' capital and borrowings):

issue of shares or debentures; long-term or short-term borrowings;
buy-back of shares, redemption of debentures, repayment of loans;
interest and dividends paid (including interim dividend).

Interest and dividend rules (the favourite MCQ).

Non-financial enterprise: interest and dividend received → investing; interest and dividend paid → financing.
Financial enterprise (bank, NBFC, investment company): interest received, dividend received and interest paid → operating; dividend paid → financing.

Non-cash transactions are excluded: issue of bonus shares, conversion of debentures into shares, purchase of assets by issuing shares or debentures to vendors.

Classification of Cash Flow Activities: key facts

Net change in cash: Net cash from operating + investing + financing activities; = Closing − opening cash and cash equivalents.
Cash equivalent test: Short-term, highly liquid, readily convertible, insignificant risk, maturity ≤ 3 months from acquisition
Non-financial enterprise: 1.Interest/dividend received
2.investing; interest/dividend paid
3.financing
Financial enterprise: 1.Interest received, dividend received, interest paid
2.operating; dividend paid
3.financing

How to answer Classification of Cash Flow Activities questions

Classification questions turn on three quick questions about each transaction.

1Does cash or a cash equivalent actually move? If not (bonus shares, assets for shares), exclude it.
2Is it a movement between cash and cash equivalents? If yes, exclude it.
3Is it part of the main business (revenue-producing)? Operating.
4Is it about long-term assets or investments? Investing.
5Is it about owners' capital or borrowings, or paying interest and dividend (non-financial firm)? Financing.
6Check whether the enterprise is financial; apply the interest and dividend rules.

Classification of Cash Flow Activities in real life

The idea, met in an everyday situation. Answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Three activities in a household

Suppose a family earns salaries of ₹6,00,000 in a year and spends ₹4,20,000 on food, rent and bills. It also buys a car for ₹3,00,000, paying partly with a car loan of ₹2,00,000 taken during the year.

Classify the flows as if the family were a business and find its net change in cash.

Try it first, then show the solutionSolution

Operating: 6,00,000 − 4,20,000 = +1,80,000.
Investing: car purchased −3,00,000.
Financing: car loan +2,00,000.
Net change = 1,80,000 − 3,00,000 + 2,00,000 = +80,000.

Answer: Operating +₹1,80,000, investing −₹3,00,000, financing +₹2,00,000; cash rises by ₹80,000. The loan, not regular earnings, paid for most of the car, just as a Cash Flow Statement would reveal for a company.

Memory hook: Earn and spend = operating; buy to keep = investing; borrow or repay = financing.

Tricks to remember Classification of Cash Flow Activities

Short memory aids. Say each one aloud once, then use it on a question the same day.

Run, Build, Fund
Operating runs the business; investing builds long-term assets; financing funds it.
Use it when: Quick classification.
Receive → Invest, Pay → Finance
For a non-financial firm, interest and dividend received are investing; paid are financing.
Use it when: Interest and dividend MCQs.
Bank? It's operating
For a finance company, interest and dividends received and interest paid are operating; only dividend paid is financing.
Use it when: Financial enterprise cases.

Classification of Cash Flow Activities: solved examples

Ordered from board level to HOTS. Try each one before you open the solution.

Example 1: Purchase of goodwill · 1 mark · MCQBoard level

Purchase of goodwill for cash is classified as:
(a) operating activity
(b) investing activity
(c) financing activity
(d) cash equivalent

Try it first, then show the solutionSolution

Goodwill is a long-term intangible asset; buying it is investing.

Answer: (b) investing activity

Example 2: Classify six transactions · 3 marks · Short answerBoard level

Classify for a manufacturing company: (i) cash received from customers; (ii) purchase of machinery; (iii) issue of equity shares; (iv) interest received on investments; (v) dividend paid; (vi) income tax paid. (3 marks)

Try it first, then show the solutionSolution

(i) Operating; (ii) Investing.
(iii) Financing; (iv) Investing (non-financial enterprise).
(v) Financing; (vi) Operating.

Answer: Operating: (i), (vi). Investing: (ii), (iv). Financing: (iii), (v).

Example 3: A finance company · 3 marks · Short answerHarder board level

Classify these for an investment company: (i) interest received on loans given; (ii) dividend received on shares held; (iii) interest paid on borrowings; (iv) dividend paid to its shareholders. (3 marks)

Try it first, then show the solutionSolution

For a financial enterprise, lending and investing are its main business.
(i), (ii) and (iii) are operating activities.
(iv) Dividend paid is a financing activity.

Answer: Operating: (i), (ii), (iii). Financing: (iv).

Example 4: Net cash from investing and financing · 4 marks · Short answerHarder board level

A manufacturing company: purchased machinery ₹2,00,000; sold old machinery ₹30,000; purchased long-term investments ₹50,000; interest received ₹10,000; dividend received ₹5,000; issued shares ₹3,00,000; repaid a loan ₹1,00,000; paid interest ₹40,000; paid dividend ₹60,000. Calculate net cash from investing and financing activities. (4 marks)

Try it first, then show the solutionSolution

Investing: −2,00,000 + 30,000 − 50,000 + 10,000 + 5,000 = −₹2,05,000.
Financing: +3,00,000 − 1,00,000 − 40,000 − 60,000 = +₹1,00,000.

Answer: Net cash used in investing ₹2,05,000; net cash from financing ₹1,00,000.

Example 5: What stays out · 4 marks · Short answerHOTS / competency

Which of the following appear in a company's Cash Flow Statement? Give reasons. (i) Conversion of debentures into equity shares; (ii) issue of bonus shares; (iii) purchase of a building by issuing shares to the vendor; (iv) purchase of 60-day treasury bills out of the bank balance. (4 marks)

Try it first, then show the solutionSolution

(i), (ii), (iii) are non-cash transactions: no cash or cash equivalent moves.
(iv) 60-day treasury bills are cash equivalents; moving bank money into them is a movement within cash and cash equivalents.
So none of them appears.

Answer: None appears: (i)-(iii) are non-cash transactions and (iv) is a movement within cash and cash equivalents.

Example 6: Dividend received by a manufacturer · 1 mark · Assertion-reasonHOTS / competency

Assertion (A): For a manufacturing company, dividend received is an investing activity.
Reason (R): It is a return on investments, which are not part of the company's principal revenue-producing activities.
(a) Both A and R are true, and R is the correct explanation of A.
(b) Both A and R are true, but R is not the correct explanation of A.
(c) A is true, but R is false.
(d) A is false, but R is true.

Try it first, then show the solutionSolution

A non-financial company earns dividend from investments, an investing activity. R explains A.

Answer: (a) Both A and R are true, and R is the correct explanation of A.

Where students lose marks in Classification of Cash Flow Activities

The slips examiners see most often, and what to write instead.

Mistake: Treating interest received by a manufacturer as operating
It appears in the Statement of Profit and Loss.
Wrong working
Interest received → operating.
Right working
Non-financial enterprise: investing.
Do this: Check the type of enterprise first.
Usually costs: 1 mark.
Mistake: Showing bonus shares as a financing inflow
Share capital increases.
Wrong working
Issue of bonus shares +1,00,000 under financing.
Right working
Excluded: non-cash transaction.
Do this: Ask whether cash moved.
Usually costs: 1 mark.
Mistake: Classifying bank overdraft as cash
It is a bank account.
Wrong working
Overdraft netted against cash balance.
Right working
CBSE: bank overdraft and cash credit are short-term borrowings (financing).
Do this: Follow the syllabus note.
Usually costs: 1 mark.
Mistake: Classifying income tax paid as financing
It is paid to government like dividend to owners.
Wrong working
Tax paid → financing.
Right working
Tax paid → operating (unless specifically identified with another activity).
Do this: Taxes arise from operating profit.
Usually costs: 1 mark.

Exam tips

Write 'non-financial enterprise' or 'financial enterprise' before classifying interest and dividends.
For excluded items, write the reason: 'non-cash transaction' or 'movement within cash and cash equivalents'.
Show inflows as + and outflows in brackets.
Classification is the most frequent 1-mark Cash Flow MCQ; computations feed into the 6-mark statement.

Practice questions on Classification of Cash Flow Activities

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

Q1 · 1 mark · MCQBoard level
Which of the following is a financing activity?
(a) Purchase of patents
(b) Redemption of debentures
(c) Cash paid to suppliers
(d) Sale of investments
Hint
Borrowings.
Answer
(b) Redemption of debentures
Q2 · 1 mark · MCQBoard level
Cash equivalents normally have a maturity of:
(a) 3 months or less from the date of acquisition
(b) 6 months or less
(c) 12 months or less
(d) more than 12 months
Hint
AS 3.
Answer
(a) 3 months or less from the date of acquisition
Q3 · 3 marks · Short answerBoard level
Classify for a trading company: (i) cash sales; (ii) payment of salaries; (iii) purchase of a delivery van; (iv) long-term loan taken from a bank; (v) sale of shares held as a long-term investment; (vi) interim dividend paid. (3 marks)
Hint
Two of each.
Answer
Operating: (i), (ii). Investing: (iii), (v). Financing: (iv), (vi).
Q4 · 1 mark · Very short answerHarder board level
A manufacturing company sold long-term investments for ₹80,000 (including a profit of ₹10,000) and bought land for ₹1,50,000. Calculate net cash from investing activities. (1 mark)
Hint
Use the cash received, not the profit.
Answer
80,000 − 1,50,000 = −₹70,000 (net cash used).
Q5 · 3 marks · Short answerHarder board level
A company issued equity shares of ₹2,00,000 at a 10% premium, redeemed debentures of ₹1,00,000 at a 5% premium, paid debenture interest ₹9,000 and paid an interim dividend ₹30,000. Calculate net cash from financing activities. (3 marks)
Hint
Include premiums in cash amounts.
Answer
+2,20,000 − 1,05,000 − 9,000 − 30,000 = ₹76,000.
Q6 · 3 marks · Short answerHarder board level
How does the CBSE syllabus treat bank overdraft and current investments in a Cash Flow Statement? (3 marks)
Hint
Two syllabus notes.
Answer
Bank overdraft and cash credit are treated as short-term borrowings, so changes in them are financing activities, not part of cash. Current investments are taken as marketable securities, part of cash equivalents, unless the question says otherwise.
Q7 · 3 marks · Short answerHarder board level
Classify these for a bank and for a manufacturing company: (i) interest received; (ii) interest paid. (3 marks)
Hint
Financial vs non-financial.
Answer
Bank: (i) operating, (ii) operating. Manufacturer: (i) investing, (ii) financing.
Q8 · 1 mark · Assertion-reasonHarder board level
Assertion (A): Issue of bonus shares is shown as an inflow under financing activities.
Reason (R): Issue of bonus shares is a non-cash transaction.
(a) Both A and R are true, and R is the correct explanation of A.
(b) Both A and R are true, but R is not the correct explanation of A.
(c) A is true, but R is false.
(d) A is false, but R is true.
Hint
No cash comes in.
Answer
(d) A is false, but R is true.
Q9 · 3 marks · Short answerHOTS / competency
Net cash from operating activities is ₹1,20,000, from investing activities (−)₹2,05,000 and from financing activities ₹1,00,000. Opening cash and cash equivalents are ₹40,000. Find the net change and closing cash and cash equivalents. (3 marks)
Hint
Add the three.
Answer
Net increase = 1,20,000 − 2,05,000 + 1,00,000 = ₹15,000; closing = 40,000 + 15,000 = ₹55,000.
Q10 · 3 marks · Short answerHOTS / competency
Explain why buying short-term treasury bills (maturity 2 months) with money from the bank does not appear in a Cash Flow Statement. (3 marks)
Hint
What is 'cash' in AS 3?
Answer
AS 3 treats cash and cash equivalents as one pool. Treasury bills maturing within 3 months are cash equivalents, so moving money from the bank into them only changes the form of the pool, not its total. It is part of cash management, not an operating, investing or financing activity.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1.Dividend paid by a manufacturing company: which activity?Show answer
Financing.
2.Interest received by a bank: which activity?Show answer
Operating.
3.Income tax paid: which activity?Show answer
Operating (unless specifically identified with investing or financing).
4.Is conversion of debentures into shares shown?Show answer
No; non-cash transaction.
5.Maturity limit for cash equivalents?Show answer
Three months or less from acquisition.

Classification of Cash Flow Activities: frequently asked questions

What are the three activities in a Cash Flow Statement?

Operating (principal revenue-producing), investing (long-term assets and investments) and financing (owners' capital and borrowings), as per AS 3.

Where does interest paid go?

Financing for a non-financial company; operating for a financial enterprise.

Are non-cash transactions disclosed anywhere?

They are excluded from the statement itself; AS 3 requires them to be disclosed elsewhere in the financial statements.

Is the direct method in the 2026-27 syllabus?

No. Only the indirect method is used for operating activities.