For the year ended 31st March 2025, Sona Ltd. made a profit of Rs. 4,00,000 after charging depreciation of Rs. 75,000 on fixed assets and a transfer of Rs. 1,50,000 to general reserve. Goodwill written off during the year was Rs. 80,000. The company sold machinery of the book value of Rs. 90,000 at Rs. 95,000. During the year, trade receivables increased by Rs. 40,000 and trade payables increased by Rs. 30,000. Prepaid expenses increased by Rs. 2,000 and outstanding wages decreased by Rs. 20,000.
Calculate cash flows from operating activities.
For the year ended 31st March 2025, Sona Ltd. made a profit of Rs. 4,00,000 after charging depreciation of Rs. 75,000 on fixed assets and a transfer of Rs. 1,50,000 to general reserve. Goodwill written off during the year was Rs. 80,000. The company sold machinery of the book value of Rs. 90,000 at Rs. 95,000. During the year, trade receivables increased by Rs. 40,000 and trade payables increased by Rs. 30,000. Prepaid expenses increased by Rs. 2,000 and outstanding wages decreased by Rs. 20,000.
Calculate cash flows from operating activities.
Cash Flow from Operating Activities (Indirect Method) — Sona Ltd., year ended 31st March, 2025:
| Particulars | Rs. |
|---|---|
| Net Profit as per Statement of Profit and Loss | 4,00,000 |
| Add: Transfer to General Reserve (appropriation, added back) | 1,50,000 |
| Net Profit before Tax and Extraordinary Items | 5,50,000 |
| Add: Depreciation on Fixed Assets | 75,000 |
| Add: Goodwill written off | 80,000 |
| Less: Gain on Sale of Machinery (95,000 − 90,000) | (5,000) |
| Operating Profit before Working Capital Changes | 7,00,000 |
| Add: Increase in Trade Payables | 30,000 |
| Less: Increase in Trade Receivables | (40,000) |
| Less: Increase in Prepaid Expenses | (2,000) |
| Less: Decrease in Outstanding Wages | (20,000) |
| Cash Flow from Operating Activities | 6,68,000 |
Marking Scheme
- 11 mark: correctly adding back transfer to General Reserve to reach Net Profit before Tax and Extraordinary Items.
- 21 mark: correctly adding back Depreciation and Goodwill written off.
- 31 mark: correctly deducting the Rs. 5,000 gain on sale of machinery (not the full proceeds).
- 41 mark: correct treatment of working capital changes (Trade Receivables, Trade Payables, Prepaid Expenses, Outstanding Wages).
- 51 mark: correct sub-total 'Operating Profit before Working Capital Changes' (Rs. 7,00,000).
- 61 mark: correct final figure — Cash Flow from Operating Activities = Rs. 6,68,000.
Hint
Add back non-cash/non-operating items to profit, then adjust for working-capital movements: ; .
Quick Oral Answer
Starting from the reported profit of Rs. 4,00,000, I add back the reserve transfer, depreciation and goodwill written off, deduct the Rs. 5,000 gain on machinery sale, and adjust for working capital changes, arriving at Cash Flow from Operating Activities of Rs. 6,68,000.
Analysis & Explanation
Concept: The Indirect Method starts from Net Profit and reverse-adjusts non-cash items, non-operating items, and working capital changes to arrive at actual cash generated from operations.
Step logic:
- The transfer to General Reserve is an appropriation of profit, not an expense — since it is already deducted in arriving at the reported Rs. 4,00,000 profit, it must be added back to reach Net Profit before Tax and Extraordinary Items.
- Depreciation and Goodwill written off are non-cash expenses — added back as they reduced book profit without any cash outflow.
- Gain on sale of machinery (Rs. 5,000) is a non-operating gain (relates to Investing Activity) — deducted here to avoid overstating operating cash flow; the full sale proceeds (Rs. 95,000) will instead appear as a cash inflow under Investing Activities.
- Increases in current assets (Trade Receivables, Prepaid Expenses) reduce cash — deducted; an increase in a current liability (Trade Payables) releases cash — added; a decrease in a current liability (Outstanding Wages) means cash was paid out — deducted.
Exam trap: A very common error is adding the full sale proceeds of machinery (Rs. 95,000) instead of only removing the Rs. 5,000 gain — the asset's book value and profit on sale belong to Investing Activities, not Operating Activities.
Common Mistakes
- 1Adding the entire Rs. 95,000 sale proceeds of machinery instead of only the Rs. 5,000 gain, which wrongly inflates operating cash flow.
- 2Forgetting to add back the transfer to General Reserve since it is an appropriation, not an expense, already embedded in the reported profit.
- 3Reversing the direction of adjustment for working capital items — e.g. treating an increase in Trade Receivables as a cash inflow instead of a cash outflow.
Interesting Facts
AS-3 (revised) requires the Indirect Method reconciliation to start from Net Profit before Tax and Extraordinary items, not Profit after Tax, to avoid distortion from tax timing differences.
Depreciation is often mistaken for a 'source of cash' — it isn't; it is added back purely because it was a non-cash deduction, not because it generates cash.
Real companies like Infosys and TCS disclose full Cash Flow Statements using this exact Indirect Method format in their annual reports, making this a directly transferable real-world skill.
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Frequently Asked Questions
Why is the transfer to General Reserve added back to Net Profit?
Because it is an appropriation of profit (not an expense) that was already deducted to arrive at the reported Rs. 4,00,000 profit; adding it back restores Net Profit before Tax and Extraordinary Items, the correct starting point for the Indirect Method.
Why is only Rs. 5,000 deducted for the machinery sale, not the full Rs. 95,000?
Only the gain (Sale Price Rs. 95,000 − Book Value Rs. 90,000 = Rs. 5,000) is a non-operating item embedded in profit and must be removed here; the full Rs. 95,000 proceeds are shown separately as a cash inflow under Investing Activities.