AccountsISC Class 12 · Cash Flow Statement

Cash Flow from Operating Activities, Indirect Method: ISC Class 12 Accounts

Updated 17 October 2026 · Draft, not yet fact-checked

Under the indirect method, start with net profit before tax (shown in a working note), add back non-cash and non-operating charges such as depreciation, loss on sale of assets and finance costs, deduct non-operating incomes such as interest, dividend and profit on sale of assets, adjust for changes in working capital, and subtract tax paid. The result is net cash from operating activities.

Start from profit, undo non-cash and non-operating items, adjust working capital, then subtract tax paid to reach operating cash.

Illustration drawn for QuestionBuddy.

Understand Cash Flow from Operating Activities: Indirect Method

Why indirect. The ISC syllabus allows only the indirect method for operating activities. It starts from profit and works towards cash by undoing everything that profit includes but cash does not. An adjusted Profit and Loss Account is not accepted as the working.

Step 1: Net profit before tax (working note). Profit before tax is often not given; it must be found from the Balance Sheets and shown as a Working Note:

Net profit before tax = Closing surplus − Opening surplus + Transfers to reserves + Interim dividend paid + Dividend of the previous year paid this year + Provision for tax made for the year

(Opening and closing surplus mean the balance of the Statement of Profit and Loss; a debit balance is negative.) This follows from the syllabus limits: dividend proposed for the previous year is an outflow in the current year, the current year's proposed dividend gets no effect, and the profit is measured before tax.

Step 2: Non-cash and non-operating adjustments.

Add back: depreciation and amortisation (non-cash); loss on sale of PPE or investments (non-operating); finance costs (interest on borrowings; the payment goes to financing).
Deduct: profit on sale of PPE or investments; interest and dividend received on investments (these go to investing).

The result is operating profit before working capital changes.

Step 3: Working capital changes. Changes in current assets and current liabilities that belong to operations:

Increase in inventories or trade receivables: deduct. Decrease: add.
Increase in trade payables or outstanding expenses: add. Decrease: deduct.
Prepaid expenses and accrued income follow the same rule as current assets.

Items classified elsewhere, such as short-term borrowings (financing) and short-term loans given (investing), are not working capital changes of operations.

Step 4: Cash generated from operations, then tax. Subtract tax paid.
Tax paid = Opening provision for tax + Provision made in the year − Closing provision for tax.

Provision for doubtful debts. The syllabus allows two treatments, which give the same result: (a) treat it as a charge against profit, adding back the provision charged and deducting the increase in gross debtors, or (b) include it in working capital by deducting the increase in net debtors. Use whichever the question suggests, and do not use both.

Investing and financing activities, and a full statement from two Balance Sheets, are on the next topic page.

Cash Flow from Operating Activities: Indirect Method: key facts

Net profit before tax: Closing surplus − Opening surplus
add Transfers to reserves
add Interim dividend paid
add Previous year dividend paid
add Provision for tax of the year; Working note; a debit surplus is negative.
Operating profit before working capital changes: Net profit before tax
add Depreciation, amortisation, loss on sale, finance costs
less Profit on sale, interest and dividend received; Indirect method.
Cash generated from operations: Operating profit before working capital changes
less Increase in current assets
add Increase in current liabilities; Reverse signs for decreases.
Tax paid: Opening provision for tax
add Provision made in the year
less Closing provision for tax; Shown after cash generated from operations.
Net cash from operating activities: Cash generated from operations | less Tax paid; First section of the statement.

How to answer Cash Flow from Operating Activities: Indirect Method questions

Work in this order; each step feeds the next.

1Write the working note for net profit before tax.
2Add back non-cash and financing charges; deduct investing incomes and profits.
3Write each working capital change with its sign.
4Total to cash generated from operations.
5Deduct tax paid, calculated from the provision account.

Cash Flow from Operating Activities: Indirect Method 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.

From profit to cash

Suppose a bakery company reports a profit before tax of ₹2,00,000 after charging depreciation of ₹20,000 and interest of ₹10,000. Stock rose by ₹15,000 and creditors rose by ₹5,000. It paid tax of ₹40,000.

What is its net cash from operating activities?

Try it first, then show the solutionSolution

2,00,000 + 20,000 + 10,000 = 2,30,000.
Working capital: −15,000 + 5,000 = −10,000, so cash generated = 2,20,000.
Less tax paid 40,000 = ₹1,80,000.

Answer: ₹1,80,000 net cash from operating activities.

Memory hook: Add back what did not leave, then settle with working capital and tax.

Tricks to remember Cash Flow from Operating Activities: Indirect Method

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

D-L-I add; P-I-D deduct
Add depreciation, loss, interest paid; deduct profit on sale, interest and dividend received.
Use it when: Adjustments to profit.
Assets up, cash down
Increase in current assets deducts; increase in current liabilities adds.
Use it when: Working capital changes.
Open + made − close
Tax paid = opening provision + made in the year − closing provision.
Use it when: Tax paid.

Cash Flow from Operating Activities: Indirect Method: solved examples

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

Example 1: Which adjustment is added back? · 1 mark · MCQBoard level

In the indirect method, which of these is added back to net profit before tax?
(a) Profit on sale of machinery
(b) Depreciation
(c) Interest received on investments
(d) Increase in trade receivables

Try it first, then show the solutionSolution

Depreciation is charged to profit but involves no cash outflow.
The other three would be deducted.

Answer: (b) Depreciation

Example 2: Tax paid · 3 marks · Short answerBoard level

The provision for tax account of a company showed an opening balance of ₹30,000, a charge of ₹45,000 for the year to the Statement of Profit and Loss and a closing balance of ₹38,000. Find the tax paid and state where it is shown. (3 marks)

Try it first, then show the solutionSolution

Tax paid = 30,000 + 45,000 − 38,000 = ₹37,000.
It is shown in operating activities, deducted from cash generated from operations.

Answer: Tax paid ₹37,000, shown in operating activities.

Example 3: Complete operating section with working note · 6 marks · Long answerHarder board level

From the following of Lark Ltd. for the year ended 31st March 2026, calculate the net cash from operating activities. Surplus (Statement of Profit and Loss): opening ₹1,20,000, closing ₹2,10,000. ₹30,000 was transferred to General Reserve, interim dividend of ₹20,000 was paid, and the previous year's proposed dividend of ₹25,000 was paid. Provision for tax: opening ₹40,000, closing ₹55,000, tax paid ₹35,000. Depreciation ₹45,000; loss on sale of machinery ₹8,000; interest on debentures ₹12,000 charged; interest received on investments ₹6,000 credited; profit on sale of investments ₹4,000 credited. Inventories rose from ₹1,60,000 to ₹1,90,000; trade receivables from ₹1,10,000 to ₹1,40,000; trade payables from ₹90,000 to ₹1,05,000; prepaid expenses fell from ₹6,000 to ₹4,000; outstanding expenses rose from ₹10,000 to ₹14,000. (6 marks)

Try it first, then show the solutionSolution

Provision made in the year = 55,000 − 40,000 + 35,000 = ₹50,000.
Net profit before tax = (2,10,000 − 1,20,000) + 30,000 + 20,000 + 25,000 + 50,000 = ₹2,15,000.
Operating profit before working capital changes = 2,15,000 + 45,000 + 8,000 + 12,000 − 6,000 − 4,000 = ₹2,70,000.
Working capital changes = −30,000 − 30,000 + 15,000 + 2,000 + 4,000 = −₹39,000.
Cash generated = 2,70,000 − 39,000 = ₹2,31,000; less tax paid 35,000 = ₹1,96,000.

Answer:

Working Note: Net profit before tax	₹
Closing surplus	2,10,000
Less: Opening surplus	(1,20,000)
Increase in surplus	90,000
Add: Transfer to General Reserve	30,000
Add: Interim dividend paid	20,000
Add: Previous year's proposed dividend paid	25,000
Add: Provision for tax made this year (55,000 − 40,000 + 35,000)	50,000
Net profit before tax	2,15,000

Particulars	₹
A. Cash flows from operating activities
Net profit before tax (Working Note)	2,15,000
Add: Depreciation	45,000
Add: Loss on sale of machinery	8,000
Add: Interest on debentures (finance cost)	12,000
Less: Interest received on investments	(6,000)
Less: Profit on sale of investments	(4,000)
Operating profit before working capital changes	2,70,000
Increase in inventories (1,60,000 to 1,90,000)	(30,000)
Increase in trade receivables (1,10,000 to 1,40,000)	(30,000)
Increase in trade payables (90,000 to 1,05,000)	15,000
Decrease in prepaid expenses (6,000 to 4,000)	2,000
Increase in outstanding expenses (10,000 to 14,000)	4,000
Cash generated from operations	2,31,000
Less: Tax paid	(35,000)
Net cash from operating activities	1,96,000

Example 4: Net profit before tax from surplus and provisions · 3 marks · Short answerHarder board level

The Statement of Profit and Loss balance of a company was ₹80,000 (credit) at the start and ₹1,35,000 at the end of the year. During the year ₹25,000 was transferred to General Reserve, ₹15,000 interim dividend was paid and the previous year's proposed dividend of ₹30,000 was paid. Provision for tax moved from ₹60,000 to ₹75,000 and tax paid was ₹50,000. Find the net profit before tax. (3 marks)

Try it first, then show the solutionSolution

Provision made = 75,000 − 60,000 + 50,000 = ₹65,000.
Increase in surplus = 1,35,000 − 80,000 = ₹55,000.
Net profit before tax = 55,000 + 25,000 + 15,000 + 30,000 + 65,000 = ₹1,90,000.

Answer: Net profit before tax = ₹1,90,000.

Example 5: Two treatments of the provision for doubtful debts · 3 marks · Short answerHOTS / competency

Net profit before tax is ₹2,00,000. Gross debtors rose from ₹1,20,000 to ₹1,50,000 and the provision for doubtful debts from ₹6,000 to ₹9,000 (the extra ₹3,000 was charged to profit). Show that treating the provision as a charge against profit and treating it as part of working capital give the same effect on cash from operations (ignore other items). (3 marks)

Try it first, then show the solutionSolution

Method (a): 2,00,000 + 3,000 (provision charged) − 30,000 (increase in gross debtors) = ₹1,73,000.
Method (b): net debtors rose from 1,14,000 to 1,41,000, an increase of 27,000; 2,00,000 − 27,000 = ₹1,73,000.
Both give ₹1,73,000. The error is to add back the 3,000 and also deduct the increase in net debtors.

Answer: Both methods give ₹1,73,000; the provision must be treated in one way only.

Where students lose marks in Cash Flow from Operating Activities: Indirect Method

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

Mistake: Starting with profit after tax
Picking up the last line of the Statement of Profit and Loss.
Wrong working
Start 1,60,000 (PAT) + 45,000 ...
Right working
Start 2,00,000 (net profit before tax from the working note)
Do this: Add the provision for tax of the year back, in a working note.
Usually costs: 2-3 marks.
Mistake: Wrong sign on increase in debtors
Treating an increase in an asset as a gain.
Wrong working
+30,000
Right working
−30,000
Do this: More money tied in debtors means less cash.
Usually costs: 1-2 marks.
Mistake: Deducting the closing provision as tax paid
Using the Balance Sheet figure.
Wrong working
Tax paid = 55,000
Right working
Tax paid = 40,000 + 50,000 − 55,000 = 35,000
Do this: Build the provision account.
Usually costs: 1-2 marks.
Mistake: Deducting proposed dividend of the current year
It appears in the notes.
Wrong working
NPBT − 80,000 proposed dividend
Right working
No effect for current-year proposed dividend
Do this: Only the previous year's dividend paid in the year matters.
Usually costs: 1-2 marks.

Exam tips

Show the NPBT working note even if you can do it in your head; the syllabus asks for it.
Write each adjustment on its own line with Add or Less.
Label the sub-totals: operating profit before working capital changes, cash generated from operations.
Check the final operating figure by reading the signs again.

Practice questions on Cash Flow from Operating Activities: Indirect Method

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
An increase in trade payables during the year is, in the indirect method:
(a) deducted from net profit
(b) added to operating profit before working capital changes
(c) shown under financing activities
(d) ignored
Hint
More credit means cash was retained.
Answer
(b) added to operating profit before working capital changes
Q2 · 3 marks · Short answerBoard level
State whether each is added to or deducted from net profit before tax: (i) loss on sale of plant; (ii) dividend received; (iii) interest paid on debentures; (iv) decrease in inventories; (v) increase in prepaid expenses; (vi) profit on sale of investments. (3 marks)
Hint
Non-cash, non-operating, or working capital?
Answer
(i) Add; (ii) Deduct; (iii) Add; (iv) Add; (v) Deduct; (vi) Deduct.
Q3 · 3 marks · Short answerHarder board level
Surplus: opening ₹55,000, closing ₹1,20,000. Transfer to General Reserve ₹20,000; interim dividend paid ₹10,000; previous year's proposed dividend paid ₹22,000. Provision for tax: opening ₹28,000, closing ₹35,000; tax paid ₹24,000. Calculate the net profit before tax. (3 marks)
Hint
Provision made = 35,000 − 28,000 + 24,000.
Answer
Provision made = 31,000. Net profit before tax = 65,000 + 20,000 + 10,000 + 22,000 + 31,000 = ₹1,48,000.
Q4 · 6 marks · Long answerHarder board level
Net profit before tax ₹3,00,000. Depreciation ₹70,000; amortisation of patents ₹10,000; interest on loans ₹18,000; dividend received ₹9,000; profit on sale of machine ₹12,000. Inventories decreased by ₹25,000; trade receivables increased by ₹40,000; trade payables decreased by ₹15,000; outstanding expenses increased by ₹5,000. Tax paid ₹60,000. Calculate net cash from operating activities. (6 marks)
Hint
Operating profit before working capital changes first.
Answer
Operating profit before working capital changes = 3,00,000 + 70,000 + 10,000 + 18,000 − 9,000 − 12,000 = ₹3,77,000. Working capital changes = 25,000 − 40,000 − 15,000 + 5,000 = −₹25,000. Cash generated = ₹3,52,000. Less tax paid 60,000 = ₹2,92,000.
Q5 · 3 marks · Short answerHOTS / competency
A student starts the operating section of Quill Ltd. with profit after tax ₹1,20,000, ignoring a provision for tax of ₹40,000 made this year, and deducts a proposed dividend of ₹50,000 for the current year. Depreciation ₹30,000 is the only other adjustment. Find the correct operating profit before working capital changes and the student's error. (3 marks)
Hint
Which two steps are wrong?
Answer
Correct = (1,20,000 + 40,000) + 30,000 = ₹1,90,000. The student got 1,20,000 − 50,000 + 30,000 = ₹1,00,000, an error of ₹90,000, from ignoring the tax provision (40,000) and deducting the current year's proposed dividend (50,000).

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.Which method for operating activities does the ISC syllabus allow?Show answer
Indirect method only.
2.Starting figure of the indirect method?Show answer
Net profit before tax.
3.Tax paid formula?Show answer
Opening provision + provision made − closing provision.
4.Increase in inventories: effect on operating cash?Show answer
Deducted.
5.Is current-year proposed dividend an outflow?Show answer
No.

Cash Flow from Operating Activities: Indirect Method: frequently asked questions

Why add back interest paid in the operating section?

Interest paid is a financing outflow, so it is added back to profit here and shown in financing.

What if the net profit before tax is given?

Use it directly; the working note is needed only when it must be derived.

Where do I show tax paid?

At the end of the operating section, after cash generated from operations.

Is the direct method tested?

No. The syllabus allows the indirect method only.