Ind AS 7 – Statement of Cash Flows: Direct vs Indirect Method & Complete Guide
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Reviewed by CA Nikhil Gupta · Last reviewed 4 June 2025
📋 Table of Contents
| Structural block | What it covers |
|---|---|
| Objective and scope | Requires information about historical changes in cash and cash equivalents through a statement classifying flows into operating, investing and financing activities. Applies to every entity presenting Ind AS financial statements. |
| Operating activities | Cash effects of the entity’s principal revenue-producing activities — can be shown by the direct method (major classes of gross receipts/payments) or the indirect method (adjusting profit for non-cash items and working-capital movements). |
| Investing activities | Cash flows from acquisition and disposal of long-term assets and other investments not classified as cash equivalents — capex, investment purchases/sales, loans given. |
| Financing activities | Cash flows that change the size and composition of the entity’s equity capital and borrowings — share issues/buybacks, dividend payments, debt drawdown/repayment. |
| Special items | Specific guidance for interest and dividends (consistently classified period to period), taxes on income (usually operating unless specifically identifiable with financing/investing), foreign currency cash flows, and non-cash transactions (excluded from the statement but disclosed separately). |
| Disclosure | Components of cash and cash equivalents and a reconciliation to the balance sheet; restricted cash balances not available for use by the group must be disclosed. |
1. Overview & Why Cash Flows Matter
The P&L account shows profit — but profit does not equal cash. A company can report strong profits while running out of cash (due to high debtors, inventory build-up, or capital expenditure), or report losses while generating strong operating cash flows (e.g., depreciation-heavy businesses like telecom or infrastructure).
Ind AS 7 mandates a Statement of Cash Flows as part of the complete financial statements. It helps users:
- Assess the entity's ability to generate cash and cash equivalents
- Evaluate the entity's liquidity and solvency
- Compare operating performance across companies without accounting policy distortions
- Understand how the company finances its investments
Warren Buffett famously prefers "owner earnings" (operating cash flows minus maintenance capex) over reported earnings — Ind AS 7 gives investors the data to compute this.
1.1 Cash and Cash Equivalents
The statement reconciles the opening and closing balance of cash and cash equivalents, which include:
- Cash on hand
- Demand deposits with banks
- Short-term, highly liquid investments with original maturities of 3 months or less (e.g., liquid mutual funds, 91-day T-bills)
- Bank overdrafts (deducted from cash and cash equivalents if repayable on demand and form an integral part of cash management)
2. Three Types of Activities
| Activity | Definition | Examples |
|---|---|---|
| Operating | Principal revenue-generating activities | Cash from customers, payments to suppliers, salaries, taxes paid |
| Investing | Acquisition/disposal of long-term assets and investments | Capex (PPE purchase), proceeds from asset sale, purchase/sale of investments |
| Financing | Changes in equity and borrowings | Share issue proceeds, loan repayments, dividends paid, interest paid on borrowings |
Every cash movement must be classified into one of these three buckets. The sum of the three gives the net change in cash during the period.
3. Indirect Method (Operating Activities)
The indirect method starts with net profit (or loss) before tax and adjusts for non-cash items and working capital changes to arrive at cash generated from operations. It is the method used by the vast majority of Indian companies.
Adjustments for non-cash/non-operating items:
Add: Depreciation & Amortisation ₹XX
Add: Finance Costs (interest expense) ₹XX
Less: Interest Income (₹XX)
Less: Dividend Income (₹XX)
Add: Loss on sale of assets ₹XX
Less: Gain on sale of assets (₹XX)
Add: Impairment losses ₹XX
Add: Provision for doubtful debts ₹XX
Operating Profit Before Working Capital Changes ₹XXX
Working Capital Changes:
(Increase)/Decrease in Trade Receivables (₹XX)
(Increase)/Decrease in Inventories (₹XX)
Increase/(Decrease) in Trade Payables ₹XX
Increase/(Decrease) in Other Liabilities ₹XX
Cash Generated from Operations ₹XXX
Less: Income Taxes Paid (₹XX)
The logic: Depreciation reduces profit but is not a cash outflow (added back). Interest expense reduces profit but is classified under financing (added back here, then shown under financing outflows). An increase in debtors means profit was recognized but cash not yet received — so deducted from operating cash flows.
4. Direct Method (Operating Activities)
The direct method shows actual cash receipts from customers and actual cash payments to suppliers, employees, and others. Ind AS 7 encourages the direct method as it provides more useful information, but most companies use indirect because it is easier to prepare from accounting records.
Cash paid to suppliers (₹XX)
Cash paid to employees (₹XX)
Cash paid for other operating expenses (₹XX)
Income taxes paid (₹XX)
5. Investing Activities
Investing activities are cash flows from acquisition and disposal of long-term assets and investments (other than those held as trading securities or cash equivalents).
Proceeds from sale of PPE ₹XX
Purchase of intangible assets (₹XX)
Purchase of investments (shares, bonds) (₹XX)
Proceeds from sale of investments ₹XX
Loans given to subsidiaries/associates (₹XX)
Loan repayments received ₹XX
Interest received (if classified here) ₹XX
Dividends received (if classified here) ₹XX
For most manufacturing and infrastructure companies, investing cash flows are significantly negative (net outflow) because capital expenditure exceeds asset disposal proceeds — this is healthy and expected for growing businesses.
6. Financing Activities
Financing activities are cash flows resulting in changes to equity and borrowings of the entity.
Payment for buyback of shares (₹XX)
Proceeds from long-term borrowings ₹XX
Repayment of long-term borrowings (₹XX)
Payment of lease liabilities (principal) (₹XX)
Dividends paid to shareholders (₹XX)
Interest paid (if classified here) (₹XX)
7. Special Items: Interest, Tax, Dividends
One of the most debated areas of Ind AS 7 is the classification of interest received, interest paid, and dividends received/paid. The standard allows flexibility:
| Item | Permitted Classification | Common Indian Practice |
|---|---|---|
| Interest Paid | Operating OR Financing | Usually Financing |
| Interest Received | Operating OR Investing | Usually Investing |
| Dividends Paid | Operating OR Financing | Usually Financing |
| Dividends Received | Operating OR Investing | Usually Investing |
| Income Tax Paid | Operating (unless specific to financing/investing) | Operating |
For financial institutions (banks, NBFCs), interest paid and received are typically classified as operating activities since interest is the core business activity.
8. Free Cash Flow & Key Ratios
Investors derive several key metrics from the cash flow statement:
| Metric | Formula | Interpretation |
|---|---|---|
| Free Cash Flow (FCF) | Operating CF – Capex | Cash available after maintaining/growing asset base |
| Operating CF Margin | Operating CF ÷ Revenue | Cash generation efficiency; should trend with EBITDA margin |
| Cash Conversion | Operating CF ÷ Net Profit | >1x means quality earnings; <1x may signal aggressive accruals |
| Capex Intensity | Capex ÷ Revenue | Higher for capital-intensive sectors (telecom, metals) |
| FCF Yield | FCF ÷ Market Cap | Cash return on investment; comparable to earnings yield |
9. Case Studies: Indian Companies
💻 Case Study 1 — TCS: Cash Flow Quality (FY2024–25)
TCS is often cited as a benchmark for cash flow quality in India. Its FY25 cash flow statement illustrates a high-quality, asset-light IT services business:
TCS classifies interest received under Investing and dividends paid under Financing. The massive negative financing CF reflects the company's policy of returning substantially all free cash to shareholders.
⚡ Case Study 2 — Adani Ports (APSEZ): Capital Allocation Story
APSEZ's FY25 cash flow statement tells a classic infrastructure growth story:
- Depreciation add-back: ₹3,102 crore (large asset base)
- Interest paid (Financing): ₹3,456 crore — significant debt financing
- Non-cash lease liability additions (Ind AS 116): disclosed separately as non-cash investing/financing
The negative FCF and reliance on debt financing is expected and sustainable for a port company with long-term concession revenues — investors track when FCF turns positive as growth capex peaks.
🏪 Case Study 3 — Zomato: From Cash Burn to Positive Operating CF
Zomato's FY25 cash flow statement marks a significant milestone in the company's evolution:
- ESOP expenses are non-cash (equity-settled) — added back in indirect method
- IPO proceeds (FY22) were classified as Financing CF — one-time boost that masked operating cash burn
Zomato's transition to positive operating CF is a key milestone analysts tracked — it signals the business model is self-sustaining without needing continuous equity dilution.
10. IGAAP vs Ind AS 7
🔴 IGAAP (AS 3)
- Also has three activities classification
- No explicit encouragement of direct method
- Bank overdrafts treated as financing
- No requirement to disclose non-cash transactions
- Lease payments: operating lease as operating CF
- Less guidance on components of cash equivalents
🟢 Ind AS 7
- Encourages direct method (though indirect permitted)
- Bank overdrafts part of cash & equivalents if repayable on demand
- Must disclose significant non-cash transactions separately
- Lease payments split: principal (financing), interest (financing/operating)
- Restricted cash must be reconciled
- More detailed guidance on classification choices
Ind AS 116 Impact on Cash Flows
Under Ind AS 116 (Leases), operating lease payments are no longer classified entirely as operating outflows. Instead:
- Principal portion of lease liability payment → Financing outflow
- Interest portion of lease liability payment → Financing or Operating (per accounting policy)
This significantly changed operating cash flows for companies with large operating lease portfolios (retail, aviation, restaurants). Flipkart/Myntra's lease costs on warehouses shifted from operating to financing CF post-Ind AS 116 adoption.
✅ Key Takeaways — Ind AS 7
- Cash flows classified into three buckets: Operating, Investing, Financing
- Indirect method (most common): starts with PBT, adjusts for non-cash and working capital changes
- Cash equivalents: maturities ≤ 3 months only
- Interest and dividends classification is flexible but must be consistent
- Ind AS 116 shifted lease principal payments to financing activities
- Non-cash transactions (asset swaps, conversion of debt to equity) must be disclosed but not on the face of the statement
- Free Cash Flow = Operating CF – Capex — the most-watched investor metric
11. Frequently Asked Questions
Net profit is based on accrual accounting, which means it includes revenue recognized but not yet collected (debtors), and excludes cash payments for assets (capitalised as capex). Operating cash flow strips out these distortions and shows the actual cash the business generated.
Signs of earnings quality concerns: If a company consistently reports high profits but low operating cash flows, it could mean: (1) Revenue is being recognized aggressively while collections lag, (2) Expenses are being capitalized instead of expensed, (3) Inventory is building up without corresponding sales.
Example: Infrastructure companies like IL&FS reported profits for years while cash flows were negative — a warning sign missed by many analysts. Conversely, Indian IT companies like TCS and Infosys consistently show operating CF > net profit, indicating high earnings quality (low working capital, no inventory, fast collections).
For valuation, many analysts use EV/FCF (Enterprise Value to Free Cash Flow) rather than P/E, as it removes accounting distortions. Warren Buffett's "owner earnings" concept uses operating CF minus maintenance capex — directly computable from the cash flow statement.
This is a common practical question in India. Ind AS 7 requires cash flows to be reported on a gross basis as a general rule, but certain items (including agent collections) can be reported on a net basis.
GST collected from customers: GST collected is not income — it is a liability (collected on behalf of the government). Therefore, cash received from customers should be shown excluding GST in the direct method. If using the indirect method, starting from PBT automatically excludes GST since revenue is reported net of GST in P&L.
TDS deducted: When a customer deducts TDS before paying, the actual cash received is net of TDS. The TDS amount is credited to the company's tax account. In cash flows: the cash receipt is the actual amount received (net of TDS), and the TDS recoverable is treated as a reduction in taxes paid rather than as cash received.
Refund of excess TDS/GST: Tax refunds received are typically classified as operating activities (since income taxes paid are operating). GST refunds (common for exporters with accumulated ITC) are also typically operating.
Non-cash transactions are investing or financing activities that do not require cash flows and therefore must be excluded from the main cash flow statement. However, Ind AS 7 requires these to be disclosed elsewhere in the financial statements (usually in Notes) so that users understand the full financing and investing activities.
Common non-cash transactions in India:
- Conversion of debentures to equity: The debt is extinguished and equity is issued — no cash changes hands. Disclosed in Notes.
- Acquisition of assets under finance lease/Ind AS 116: Recognition of ROU assets and lease liabilities at commencement is non-cash. Only actual cash payments (lease rentals) appear in the statement.
- Asset acquired via share swap in M&A: Tata Motors acquiring Jaguar Land Rover partly via share consideration — the non-cash portion excluded from cash flow statement.
- Bonus shares issued: No cash involved — transfer from reserves to share capital. Non-cash financing transaction.
- Equity-settled ESOPs vesting: ESOP expense in P&L is non-cash (share-based payment) — added back in indirect method.
The disclosure ensures users can reconstruct the full picture of capital allocation even for non-cash items. Ind AS 7 para 43 specifically requires disclosure of significant non-cash investing and financing activities.
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