It is the second week of May. Your CA hands over the draft accounts for FY 2025-26 and the profit and loss account shows a net profit of ₹18,40,000. Good year. Then you open the bank statement and the current account has ₹2,35,000 in it, down from ₹17,25,000 last April. You did not take a holiday. Nobody stole anything. Where did the profit go?
The cash flow statement answers exactly that question. It takes the same year, starts from the profit figure, and walks line by line to the change in your bank balance. Once you know how to read its three sections, the gap between "profit" and "money in the bank" stops being a mystery and becomes a list of decisions you can act on.
Why can a profitable business run short of cash?
Your P&L is prepared on the accrual basis. A sale is income the day you raise the invoice, not the day the customer pays. A purchase is an expense when it is used up, not when you pay the supplier. Depreciation is an expense even though no money leaves the bank that year. If you want the longer version of this, our note on cash vs accrual accounting covers it.
The bank account does not care about any of that. It only records money actually received and actually paid. Four things usually explain most of the difference for a small trader or manufacturer:
Customers paying later than before, so receivables pile up.
More stock sitting in the godown at year end.
Cash spent on assets (a van, a machine) that hits the P&L only slowly through depreciation.
Loan repayments, interest and owners' drawings, which reduce cash but mostly do not reduce profit.
A cash flow statement sorts every rupee of movement into one of three buckets so you can see which of these hit you, and by how much.
What are the three sections of a cash flow statement?
In India, companies following the Accounting Standards prepare it under AS 3, and Ind AS companies under Ind AS 7. The structure is the same: operating, investing and financing activities.
Section | What it captures | What you want to see over time |
|---|---|---|
Operating activities | Cash from the actual business: collections from customers, payments to suppliers and staff, rent, income tax paid | Positive, and roughly in line with profit |
Investing activities | Buying or selling fixed assets and investments, interest and dividends received | Usually negative in a growing business; that is normal |
Financing activities | Loans taken and repaid, interest paid, capital brought in, drawings or dividends paid | Depends on the stage; persistent reliance on new loans to fund operations is a warning |
One detail trips up many owners. Under AS 3, for a business that is not a financial enterprise, interest paid goes under financing activities, and interest and dividends received go under investing activities (AS 3, paragraph 30). So when you read the operating section, the bank interest on your cash credit limit is not in it. It has been moved down to financing.
How do you read the operating section line by line?
Most Indian cash flow statements use the indirect method. It does not list customer receipts and supplier payments directly. Instead it starts with net profit and adjusts it. Read it in this order:
Start with net profit before tax. This is the figure from your P&L.
Add back non-cash expenses. Depreciation and provisions reduced profit without any money leaving.
Add back interest expense, deduct interest income. They are not removed from the statement, only shifted to financing and investing.
Adjust for working capital. An increase in debtors or stock uses cash, so it is deducted. An increase in creditors means you held on to cash longer, so it is added.
Deduct income tax actually paid, including advance tax, during the year.
The working capital lines are where the story usually is. Each one is a balance sheet movement between two year ends, so you can check it against your debtor ageing and stock register.
A worked example: a profitable year that drained the bank
Say you run a hardware and plywood distribution firm in Surat, set up as a partnership. These figures are illustrative, but the pattern is common in our client files.
Line item | Amount (₹) |
|---|---|
Net profit before tax | 18,40,000 |
Add: depreciation | 3,20,000 |
Add: interest expense (shown under financing) | 2,10,000 |
Less: increase in trade receivables | (21,50,000) |
Less: increase in inventory | (9,80,000) |
Add: increase in trade payables | 6,30,000 |
Cash used in operations | (1,30,000) |
Less: income tax paid | (4,60,000) |
Net cash from operating activities | (5,90,000) |
Purchase of delivery van | (8,50,000) |
Interest received on fixed deposit | 40,000 |
Net cash from investing activities | (8,10,000) |
Vehicle loan taken | 6,00,000 |
Vehicle loan principal repaid | (1,80,000) |
Interest paid | (2,10,000) |
Partners' drawings | (3,00,000) |
Net cash from financing activities | (90,000) |
Net decrease in cash and bank | (14,90,000) |
Opening cash and bank | 17,25,000 |
Closing cash and bank | 2,35,000 |
Check the arithmetic the way an auditor would. Operating: 18,40,000 + 3,20,000 + 2,10,000 = 23,70,000. Less 21,50,000 and 9,80,000, plus 6,30,000, gives (1,30,000). Less tax of 4,60,000 gives (5,90,000). Add investing (8,10,000) and financing (90,000) and the total fall is 14,90,000. Opening 17,25,000 minus 14,90,000 leaves 2,35,000, which matches the bank.
Now read it like an owner. The business earned ₹18.4 lakh on paper but consumed ₹5.9 lakh of cash just running itself. The single biggest line is the ₹21.5 lakh jump in debtors. That money is profit you have booked and GST you have already paid on, sitting with your customers. The van was a sensible purchase, but it was mostly paid from the bank balance rather than the loan.
Which numbers should worry you first?
You do not need to analyse every line. In practice we look at four things, in this order:
Operating cash vs net profit. If operating cash is far below profit for two years running, the business is funding its customers or its stock. One year can be a growth spurt. Two is a pattern.
The receivables line. Compare the percentage growth in debtors with the percentage growth in sales. If debtors grew faster, collections have slowed.
The inventory line. Compare closing stock with the stock register and an ageing of items. Dead stock shows up here as a cash drain long before you write it off.
Financing that props up operations. New loans or larger cash credit balances in a year when operating cash is negative means borrowed money is paying for working capital. That is expensive and it tends to compound.
How do GST and TDS show up in your cash flow?
This is the part generic guides skip, and it matters for Indian SMEs. When you sell on 60-day credit, you still pay the output GST on that invoice with your GSTR-3B, which for monthly filers is due by the 20th of the following month. On a ₹10,00,000 credit sale at 18%, that is ₹1,80,000 of tax paid from your bank before the customer has paid you a rupee.
Input tax credit has a similar effect in reverse. If your purchase register has invoices that do not appear in GSTR-2B, the credit is not usable yet, and you end up paying more of your liability in cash. In the cash flow statement, both of these sit inside working capital movements (GST receivable or payable balances), so they are easy to miss. If your customers deduct TDS on payments, that amount is held back from your collections and reaches you only when you claim it against your own income tax, which affects the "income tax paid" line.
Do small businesses have to prepare a cash flow statement?
Not always. Under section 2(40) of the Companies Act, 2013, the financial statements of a one person company, a small company, a dormant company and a private company recognised as a start-up may leave out the cash flow statement. From 1 December 2025, a small company is one with paid-up capital up to ₹10 crore and turnover up to ₹100 crore, so many more private limited companies now fall in this exemption.
Proprietorships and partnerships have no Companies Act requirement either. The law not requiring it does not make it less useful. Your bank will often ask for a cash flow projection for a limit renewal, and the historical statement is the easiest way to build one that holds up.
A monthly routine to keep profit and cash in step
Reading the annual statement once in May is too late to change anything. A short monthly routine works better:
Reconcile every bank account so cash and bank balances in your books are real.
Run the cash flow report for the month and compare operating cash with the month's profit.
Open the outstanding ageing report and chase anything beyond your credit terms.
Check stock that has not moved in 90 days.
Match purchase invoices with GSTR-2B before filing GSTR-3B, so you do not pay tax in cash that credit should have covered.
Step 3 is where most of the cash comes back. Our guide on how automated reminders improve cash flow for SMEs covers the collections side in detail.
Where hisabkitab fits in
In hisabkitab the cash flow statement, P&L and balance sheet are generated from the same entries, so the reconciliation above happens without a spreadsheet. AI OCR reads bank statements and purchase bills into your books, the ageing and outstanding report shows which customers are holding your cash, and WhatsApp or email payment reminders go out on schedule. GSTR-2B AI reconciliation flags credit that has not reached you before you file. If you want to explore the reports first, the full feature list and our bookkeeping software page show how they fit together.
You can also connect Claude or ChatGPT to your books with read-only access and ask questions such as "why did operating cash fall this quarter?" in plain language.
Frequently asked questions
Why is my profit high but my bank balance low?
Usually because debtors and stock grew, you bought fixed assets, or you repaid loans and took drawings. The cash flow statement shows exactly which of these happened and how much each one cost you.
Is depreciation a cash flow?
No. Depreciation reduces profit but no money leaves the bank, so it is added back in the operating section. The cash went out when you bought the asset, under investing activities.
What is the difference between the direct and indirect method?
The direct method lists gross receipts from customers and payments to suppliers and staff. The indirect method starts with net profit and adjusts it. Both give the same operating cash figure; most Indian statements use the indirect method.
Where does interest on a business loan appear in the cash flow statement?
For a trading or manufacturing business following AS 3, interest paid is shown under financing activities, not operating activities. Interest received on deposits goes under investing activities.
Is negative operating cash flow always a bad sign?
Not for one year in a fast-growing business that is building stock and debtors. It becomes a concern when it repeats and is being covered by fresh borrowing.
How often should a small business review its cash flow?
Monthly is a good rhythm. It is frequent enough to catch slow collections or piling stock while you can still act on them.
Start a free trial to see your own cash flow statement built from your books, or compare plans to pick the one that fits your business.
