Cash flow statement: direct and indirect methods
Of the three primary financial statements, the cash flow statement is the one owners most often ignore and analysts most often read first. The reason is simple: profit is an opinion shaped by accounting choices, but cash is a fact, and businesses fail when they run out of cash regardless of what profit they reported. This guide explains how the cash flow statement is structured, the difference between the direct and indirect methods of presenting it, and why it so often tells a different story from the profit and loss.
Why cash differs from profit
The starting point is understanding that profit is not cash. A business records profit when it makes a sale, but the cash may arrive much later; it deducts depreciation as an expense though no cash leaves; it spends cash buying equipment and stock that never appears as an expense in the period; and it repays loan principal in cash that is not a cost at all. Because of all these timing and classification differences, a business can report a healthy profit while its bank balance falls, or show a loss while cash rises. The cash flow statement exists to bridge that gap — to show where cash actually came from and went, independent of the accounting profit. This is the same profit-versus-cash gap that sits at the heart of working capital management.
The three activities
The statement organises all cash movements into three categories, and the split is what gives it its analytical power:
- Operating activities — cash from the core business: receipts from customers, payments to suppliers, staff and overheads. This shows whether the day-to-day business generates or consumes cash.
- Investing activities — cash relating to long-term assets: buying or selling property and equipment, and investments. This shows how much the business is spending to build capacity.
- Financing activities — cash to and from capital providers: loans drawn and repaid, capital introduced by owners, dividends paid. This shows how the business is funded.
Reading the three together is revealing. A healthy, maturing business tends to generate cash from operations, spend some on investing, and use financing to repay debt. A business whose operations consume cash while financing inflows prop it up is showing a warning sign the profit figure alone would never reveal.
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A full statement of cash flows under the indirect method, with all three activities and the comparative. Rs in thousand.
| 2026 | 2025 | |
|---|---|---|
| CASH FLOWS FROM OPERATING ACTIVITIES | ||
| Profit before taxation | 51,000 | 39,000 |
| Adjustments for non-cash and non-operating items | ||
| Depreciation on property, plant and equipment | 24,000 | 22,000 |
| Depreciation on right-of-use assets | 4,000 | 4,000 |
| Amortisation of intangible assets | 2,000 | 2,000 |
| Finance cost | 19,000 | 17,000 |
| Gain on disposal of property, plant and equipment | (3,000) | (1,500) |
| Operating profit before working capital changes | 97,000 | 82,500 |
| Working capital changes | ||
| (Increase) in stock in trade | (12,000) | (8,000) |
| (Increase) in trade debts | (15,000) | (11,000) |
| (Increase) in contract assets | (2,000) | (1,000) |
| Decrease / (increase) in advances, deposits and prepayments | 2,000 | (3,000) |
| Increase in trade and other payables | 18,000 | 9,000 |
| Increase in contract liabilities | 3,000 | 2,000 |
| Cash generated from operations | 91,000 | 70,500 |
| Finance cost paid | (18,500) | (16,400) |
| Income tax paid | (16,200) | (12,900) |
| Net cash generated from operating activities | 56,300 | 41,200 |
| CASH FLOWS FROM INVESTING ACTIVITIES | ||
| Purchase of property, plant and equipment | (44,000) | (31,000) |
| Proceeds from disposal of property, plant and equipment | 8,000 | 4,500 |
| Net cash used in investing activities | (36,000) | (26,500) |
| CASH FLOWS FROM FINANCING ACTIVITIES | ||
| Repayment of long-term financing | (10,000) | (10,000) |
| Payment of lease liabilities — principal | (3,000) | (3,000) |
| Increase in short-term borrowings — net | 13,000 | 5,000 |
| Dividend paid | (15,000) | (15,000) |
| Net cash used in financing activities | (15,000) | (23,000) |
| Net increase / (decrease) in cash and cash equivalents | 5,300 | (8,300) |
| Cash and cash equivalents at beginning of the year | 12,700 | 21,000 |
| Cash and cash equivalents at end of the year | 18,000 | 12,700 |
The statement proves itself: closing cash of 18,000 is the cash and bank balance on the balance sheet, and 12,700 is the comparative. If the two do not agree, stop and find the difference before formatting anything — a cash flow statement that does not tie to the balance sheet is not a presentation problem, it is an error.
Note where finance cost appears twice: added back in full at 19,000 as a non-operating item, then shown as 18,500 actually paid. The 500 difference is the movement in accrued mark-up from 3,500 to 4,000. The same logic gives income tax paid of 16,200 — opening provision 9,410 plus the current charge 13,790 less closing provision 7,000.
The same statement by the direct method
Only the operating section differs. Investing and financing are identical.
| 2026 | |
|---|---|
| Cash received from customers | 466,000 |
| Cash paid to suppliers and employees | (375,000) |
| Cash generated from operations | 91,000 |
| Finance cost paid | (18,500) |
| Income tax paid | (16,200) |
| Net cash generated from operating activities | 56,300 |
Both reach 91,000 and 56,300. The direct method tells a reader what actually happened; the indirect method tells a preparer how profit became cash. The standard expresses a preference for the direct method and practice almost universally ignores it, because the indirect version can be built from two balance sheets and a profit and loss statement, while the direct version needs the cash book analysed.
What the numbers tell you
Three relationships are worth computing every time the statement is prepared.
| Measure | Calculation | On these figures | What it signals |
|---|---|---|---|
| Cash conversion | Operating cash ÷ profit before tax | 45,300 ÷ 51,000 = 89% | Profit is largely backed by cash; below about 70% sustained is a warning |
| Working capital absorption | Inventory + receivables movement less payables movement | 12,000 + 17,000 − 9,000 = Rs 20,000 thousand | Growth funded from the business rather than from lenders |
| Interest cover on a cash basis | Operating cash before interest ÷ interest paid | 63,500 ÷ 18,200 = 3.5 times | Headroom against finance cost |
A company can report growing profit and falling cash conversion at the same time, and the second is the earlier warning. It is the reason lenders read this statement before the profit and loss statement.
What IFRS 18 changes here
IFRS 18 applies to annual periods beginning on or after 1 January 2027 and touches the cash flow statement in two specific ways.
| Item | Today | Under IFRS 18 |
|---|---|---|
| Starting point for the indirect method | Diverse in practice — profit before tax, profit after tax or another line | Operating profit |
| Interest and dividends received and paid | Classification options available | Options removed for most entities |
Both changes are presentational, but neither is cosmetic: the reconciliation has to be rebuilt from a different line, and because comparatives are restated, the prior-year statement will not tie without rework. The IASB has separately signalled a broader project on the statement of cash flows, so this is a first step rather than a settled position.
Where it fits
The cash flow statement is the third member of the set that must articulate together: its closing cash ties to the cash on the balance sheet, and its indirect-method starting point is the profit from the income statement — the interlock described under financial statement preparation. For an owner, the discipline of reading it regularly is one of the best defences against the classic trap of being profitable on paper and insolvent in practice. The net movement it reports should always reconcile to the actual change in the cash and bank balance over the period; if it does not, the statement has not been built correctly.
Sources
This guide is written against the official and clearly labelled professional references below. Rates, thresholds and portal procedures change between reviews, so open the primary source before relying on a figure.
Questions people also ask
What are the three sections of a cash flow statement?
Operating, investing and financing activities. Operating covers cash from the core trading of the business — receipts from customers, payments to suppliers and staff. Investing covers cash spent on or received from long-term assets and investments. Financing covers cash from and to providers of capital — loans drawn or repaid, capital introduced, dividends paid. Splitting cash this way shows not just how much cash moved, but why.
What is the difference between the direct and indirect methods?
They are two ways to present operating cash flow. The direct method lists actual operating cash receipts and payments — cash from customers, cash paid to suppliers. The indirect method starts from profit and adjusts it for non-cash items like depreciation and for changes in working capital to arrive at operating cash flow. Both reach the same operating cash figure; the indirect method is more common because it links clearly to the profit and balance sheet.
Why does a cash flow statement matter if I already have a profit figure?
Because profit and cash are different, and a business is kept alive by cash, not profit. The cash flow statement reveals things the profit and loss hides — that profit is tied up in unpaid receivables or stock, that heavy asset purchases have drained cash, or that the business is surviving on borrowing rather than trading. It is often the most revealing of the three statements about whether a business is actually healthy.
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