JAIIB Paper 3 • Accounting & Financial Management for Bankers (AFM) âââââ
Cash Flow & Funds Flow
Why profit on paper is not the same as cash in the bank â and how bankers use both statements to judge a borrower's true repayment capacity. This guide covers the Funds Flow Statement, the concept of "Fund," the Cash Flow Statement, Operating/Investing/Financing classification, Direct vs Indirect Method, and how bankers analyse both â with 50 exam-style MCQs with hidden answers.
đ Updated: September 2026 • 27 min read
1 What is a Funds Flow Statement?
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Definition
A Funds Flow Statement shows the sources and applications of funds between two Balance Sheet dates â explaining how long-term funds were raised (e.g., fresh share capital, long-term loans, sale of fixed assets) and how they were applied (e.g., purchase of fixed assets, loan repayment, dividend payment).
It answers a question the Balance Sheet and P&L Account alone cannot: "Where did the money come from, and where did it go?" â particularly with respect to long-term financial decisions.
2 The Concept of "Fund"
Fund = Net Working CapitalCurrent Assets â Current Liabilities
In the traditional Funds Flow framework, "Fund" refers to Net Working Capital. The statement is typically supported by a Schedule of Changes in Working Capital, which lists the increase or decrease in each individual current asset and current liability item between the two Balance Sheet dates.
JAIIB tip: An increase in a current asset or a decrease in a current liability represents a use of working capital; conversely, a decrease in a current asset or an increase in a current liability represents a source of working capital.
3 What is a Cash Flow Statement?
đĩ
Definition
A Cash Flow Statement shows the actual inflows and outflows of cash and cash equivalents during a period, classified under three headings. It is governed by AS-3 (traditional) / Ind AS 7 (converged), and is a mandatory statement â alongside the Balance Sheet and P&L Account â for companies to which these standards apply.
4 Classification of Cash Flows
Operating Activities
Cash from the entity's core, revenue-generating business â receipts from customers, payments to suppliers/employees, and income tax paid.
Investing Activities
Cash used for or generated from acquisition/disposal of long-term assets and investments.
Financing Activities
Cash from changes in the size/composition of owners' capital and borrowings â share issue, loan proceeds/repayment, dividends paid.
JAIIB tip: For a bank or finance company, interest paid, interest received and dividend received are classified as Operating Activities (since lending/investing is its core business) â whereas a typical manufacturing/trading company has more flexibility in classifying interest and dividend items.
5 Direct vs Indirect Method
Method
Approach
Usage
Direct Method
Shows actual gross cash receipts and gross cash payments (e.g., cash received from customers, cash paid to suppliers)
Less common in practice, though considered more informative
Indirect Method
Starts with Net Profit and adjusts for non-cash items and working capital changes
Overwhelmingly the most common method used and tested
6 Preparing a Cash Flow Statement (Indirect Method)
Start with Net Profit Before Tax and Extraordinary Items
The reported accounting profit is the starting point.
Add Back Non-Cash / Non-Operating Expenses
Depreciation, amortisation, loss on sale of fixed assets, and provisions are added back, since they reduced profit without any cash outflow.
Deduct Non-Cash / Non-Operating Gains
Profit on sale of fixed assets or investments is deducted, since it increased profit without a corresponding operating cash inflow.
Adjust for Working Capital Changes
An increase in current assets (other than cash) is deducted; an increase in current liabilities is added â arriving at Cash Generated from Operations.
Deduct Taxes Paid
Actual income tax paid during the period is deducted to arrive at Net Cash from Operating Activities.
7 Funds Flow vs Cash Flow
Basis
Funds Flow Statement
Cash Flow Statement
Concept of "Fund"
Net Working Capital
Cash and Cash Equivalents
Focus
Long-term financial position
Short-term liquidity
Mandatory Reporting
Largely discontinued/optional today
Mandatory under AS-3/Ind AS 7 for applicable companies
Primary Utility
Long-term financial planning
Day-to-day liquidity management
8 Analysis for Bankers
Profit â Cash
A firm can be profitable on paper yet cash-starved if profits are locked up in rising receivables/inventory.
Operating Cash Flow Quality
Consistent positive cash from operations is a stronger repayment-capacity signal than accounting profit alone.
Financing Dependence
Heavy reliance on financing-activity inflows (fresh borrowing) to fund operations is a red flag for over-leverage.
Why it matters: A borrower reporting healthy Net Profit but negative cash from operations â often due to a working-capital build-up â is a classic early warning sign that credit officers are trained to probe before sanctioning or renewing a facility.
â Key Takeaways
A Funds Flow Statement tracks changes in Net Working Capital between two Balance Sheet dates; a Cash Flow Statement tracks actual movements of cash and cash equivalents.
Cash flows are classified into Operating, Investing, and Financing activities under AS-3/Ind AS 7.
The Indirect Method (starting from Net Profit, adjusting for non-cash items and working-capital changes) is far more commonly used than the Direct Method.
Funds Flow reporting is now largely optional; Cash Flow Statements are mandatory for applicable companies.
For bankers, consistent positive operating cash flow is a more reliable repayment-capacity signal than reported accounting profit.
đ Top 50 JAIIB-Style MCQs on Cash Flow & Funds Flow
Test your understanding with these 50 practice MCQs, closely modelled on the pattern expected in the JAIIB AFM exam â including combination-answer questions. Each question has 5 options â the correct answer is hidden by default; tap "Show Answer" to reveal it along with a short explanation.
đ What is a Funds Flow Statement?
1 A Funds Flow Statement shows:
A. Only cash transactions during the year
B. Sources and applications of funds between two Balance Sheet dates
C. Only the profit earned during the year
D. Only fixed asset additions
E. Only tax payments
Answer: B. It shows sources and applications of funds between two dates.
2 Which of these is a "source" of funds? (i) Issue of fresh share capital (ii) Sale of a fixed asset (iii) Repayment of a long-term loan
A. (i) only
B. (i) and (ii) only
C. (iii) only
D. All of (i), (ii) and (iii)
E. None of these
Answer: B. Share issue and asset sale are sources; loan repayment is an application.
3 A Funds Flow Statement primarily explains decisions of a:
A. Short-term, day-to-day nature only
B. Long-term financial nature
C. Purely tax-related nature
D. Marketing nature
E. HR-related nature
Answer: B. It focuses on long-term financial decisions.
4 Purchase of fixed assets is an example of a/an:
A. Source of funds
B. Application of funds
C. Neither a source nor an application
D. Operating income
E. Contingent liability
Answer: B. It is an application (use) of funds.
5 A Funds Flow Statement is prepared by comparing:
A. Two Balance Sheets at different dates
B. A single Balance Sheet in isolation
C. Only the Cash Book entries
D. Only the Trial Balance
E. Only the auditor's report
Answer: A. Two Balance Sheets at different dates are compared.
đ° The Concept of "Fund"
6 In the traditional Funds Flow framework, "Fund" refers to:
A. Cash balance only
B. Net Working Capital (Current Assets â Current Liabilities)
C. Total Assets
D. Share Capital only
E. Total Liabilities
Answer: B. "Fund" means Net Working Capital.
7 An increase in a current asset (say, Debtors) represents a:
A. Source of working capital
B. Use of working capital
C. Neither source nor use
D. A financing activity always
E. A capital expenditure
Answer: B. An increase in a current asset uses working capital.
8 An increase in a current liability (say, Creditors) represents a:
A. Source of working capital
B. Use of working capital
C. A fixed asset addition
D. A dividend payment
E. A tax refund
Answer: A. An increase in a current liability is a source of working capital.
9 The "Schedule of Changes in Working Capital" lists changes in:
A. Only fixed assets
B. Individual current asset and current liability items
C. Only share capital
D. Only long-term loans
E. Only Reserves
Answer: B. It lists changes in current assets/liabilities.
10 A decrease in a current asset represents a:
A. Source of working capital
B. Use of working capital
C. Capital expenditure
D. Financing inflow only
E. Investing outflow only
Answer: A. A decrease in a current asset is a source of working capital.
đĩ What is a Cash Flow Statement?
11 A Cash Flow Statement is governed in India by:
A. AS-3 / Ind AS 7
B. AS-1 only
C. The Negotiable Instruments Act, 1881
D. Section 92 of the Income-tax Act
E. The RTI Act, 2005
Answer: A. AS-3/Ind AS 7 governs Cash Flow Statements.
12 A Cash Flow Statement is presented alongside:
A. Only the Auditor's Report
B. The Balance Sheet and Profit & Loss Account
C. Only tax returns
D. Only the Director's Report
E. No other statement is needed
Answer: B. It accompanies the Balance Sheet and P&L Account.
13 A Cash Flow Statement tracks movements of:
A. Net Working Capital only
B. Cash and cash equivalents
C. Fixed assets only
D. Share capital only
E. Contingent liabilities
Answer: B. It tracks cash and cash equivalents.
14 "Cash equivalents" typically include:
A. Land and buildings
B. Short-term, highly liquid investments readily convertible to known amounts of cash
C. Long-term debentures
D. Goodwill
E. Preference share capital
Answer: B. Cash equivalents are short-term, highly liquid investments.
15 Which of these statements is mandatory under Ind AS/AS for applicable companies?
A. Funds Flow Statement
B. Cash Flow Statement
C. Neither is mandatory today
D. Both are equally optional
E. Only the Director's Report
Answer: B. The Cash Flow Statement is mandatory; Funds Flow largely is not.
đī¸ Classification of Cash Flows
16 Cash received from customers is classified under:
A. Investing Activities
B. Operating Activities
C. Financing Activities
D. None of these
E. Extraordinary Activities
Answer: B. Cash from customers is an Operating activity.
17 Purchase of a new machine is classified under:
A. Operating Activities
B. Investing Activities
C. Financing Activities
D. None of these
E. Extraordinary Activities
Answer: B. Machine purchase is an Investing activity.
18 Proceeds from issue of shares are classified under:
A. Operating Activities
B. Investing Activities
C. Financing Activities
D. None of these
E. Extraordinary Activities
Answer: C. Share issue proceeds are a Financing activity.
19 For a bank/finance company, interest paid and received are classified as:
A. Investing Activities always
B. Operating Activities
C. Financing Activities always
D. Extraordinary items
E. Not disclosed at all
Answer: B. For a bank/finance company, interest is an Operating activity.
20 Dividend paid to shareholders is classified under:
A. Operating Activities
B. Investing Activities
C. Financing Activities
D. None of these
E. Extraordinary Activities
Answer: C. Dividend paid is a Financing activity.
âī¸ Direct vs Indirect Method
21 The Direct Method of preparing a Cash Flow Statement shows:
A. Only Net Profit, adjusted
B. Actual gross cash receipts and gross cash payments
C. Only working capital changes
D. Only depreciation add-back
E. Only share capital movements
Answer: B. The Direct Method shows actual gross receipts/payments.
22 The Indirect Method starts from:
A. Gross Sales
B. Net Profit before tax and extraordinary items
C. Total Assets
D. Share Capital
E. Cash balance at the start of the year
Answer: B. The Indirect Method starts from Net Profit.
23 Which method is more commonly used and tested in practice?
A. Direct Method
B. Indirect Method
C. Both equally
D. Neither is used
E. A hybrid method mandated by RBI
Answer: B. The Indirect Method is far more commonly used.
24 Both Direct and Indirect methods will always arrive at:
A. Different figures for Net Cash from Operating Activities
B. The same figure for Net Cash from Operating Activities
C. Different figures for Investing Activities only
D. Different figures for Financing Activities only
E. Completely unrelated figures
Answer: B. Both methods yield the same Operating cash flow figure â only presentation differs.
25 Investing and Financing Activities sections are prepared:
A. Only under the Direct Method
B. Identically, regardless of Direct or Indirect Method used for Operating Activities
C. Only under the Indirect Method
D. Never, in any method
E. Only for banks
Answer: B. Investing/Financing sections are the same under both methods.
đ ī¸ Preparing a Cash Flow Statement
26 Under the Indirect Method, depreciation is:
A. Deducted from Net Profit
B. Added back to Net Profit
C. Ignored entirely
D. Classified as a Financing outflow
E. Classified as an Investing inflow
Answer: B. Depreciation, a non-cash charge, is added back.
27 Profit on sale of a fixed asset is:
A. Added back to Net Profit under Operating Activities
B. Deducted from Net Profit under Operating Activities (and shown as an Investing inflow)
C. Ignored completely
D. Classified as a Financing inflow
E. Never adjusted
Answer: B. It is deducted from Operating profit and shown under Investing.
28 An increase in Inventory (a current asset) during the year is:
A. Added to Net Profit
B. Deducted from Net Profit
C. Ignored entirely
D. Shown under Financing Activities
E. Shown under Investing Activities
Answer: B. An increase in inventory is deducted (a use of cash).
29 An increase in Creditors (a current liability) during the year is:
A. Added to Net Profit
B. Deducted from Net Profit
C. Ignored entirely
D. Shown under Investing Activities
E. Shown under Financing Activities only
Answer: A. An increase in creditors is added (a source of cash).
30 The final step to arrive at Net Cash from Operating Activities is to deduct:
A. Dividend paid
B. Income tax paid
C. Share capital raised
D. Loan proceeds
E. Depreciation again
Answer: B. Taxes paid are deducted at the final step.
đ Funds Flow vs Cash Flow
31 Funds Flow Statement concerns itself with:
A. Cash and cash equivalents only
B. Net Working Capital
C. Fixed assets only
D. Share premium only
E. Contingent liabilities only
Answer: B. Funds Flow tracks Net Working Capital.
32 Cash Flow Statement primarily addresses:
A. Long-term solvency only
B. Short-term liquidity
C. Tax planning only
D. Shareholder voting rights
E. Employee compensation
Answer: B. Cash Flow focuses on short-term liquidity.
33 Today, mandatory external reporting focuses on:
A. The Funds Flow Statement
B. The Cash Flow Statement
C. Neither statement
D. Both equally, with identical formats
E. Only the Director's Report
Answer: B. The Cash Flow Statement is the mandatory external report today.
34 A company can show a healthy increase in Working Capital under Funds Flow analysis while still facing:
A. Guaranteed cash surplus
B. An actual cash crunch, if the increase is locked in illiquid current assets like inventory
C. No risk whatsoever
D. Automatic loan eligibility
E. Zero need for a Cash Flow Statement
Answer: B. Working capital growth can still coexist with a cash crunch.
35 The key reason Cash Flow Statements largely superseded Funds Flow Statements in mandatory reporting is:
A. Cash is a more objective, less manipulable measure than "working capital"
B. Funds Flow Statements are illegal
C. Cash Flow Statements are easier to falsify
D. RBI banned Funds Flow reporting entirely
E. There is no real difference between them
Answer: A. Cash is a more objective, harder-to-manipulate measure.
đĻ Analysis for Bankers
36 A firm reporting strong Net Profit but negative cash from Operating Activities is most likely experiencing:
A. No issue at all
B. A working-capital build-up (e.g., rising receivables/inventory) locking up cash
C. Guaranteed insolvency
D. Excess liquidity
E. Zero credit risk
Answer: B. A working-capital build-up is the classic explanation.
37 For assessing genuine repayment capacity, bankers generally consider:
A. Accounting profit alone is always sufficient
B. Consistent positive operating cash flow as a stronger, more reliable signal
C. Only the Balance Sheet, ignoring cash flows
D. Only the Director's Report
E. Only share price movements
Answer: B. Operating cash flow is a stronger repayment-capacity signal.
38 Heavy reliance on Financing-activity inflows to fund day-to-day operations signals:
A. Excellent liquidity with no concerns
B. A possible over-leverage/sustainability concern
C. Strong operating performance
D. Zero borrowing
E. Guaranteed profitability
Answer: B. It's a red flag for over-reliance on external funding.
39 Sustained capital expenditure (investing outflow) alongside healthy operating cash flow typically signals:
A. Business decline
B. Genuine business growth
C. Imminent insolvency
D. Fraudulent reporting
E. No relevance to credit appraisal
Answer: B. It signals genuine growth funded by internal cash generation.
40 A borrower's negative operating cash flow, if noticed during credit appraisal, should prompt a banker to:
A. Ignore it, since profit is positive
B. Probe the underlying reasons before sanctioning/renewing the facility
C. Automatically sanction a higher limit
D. Report it to the Notary Public
E. Take no further action of any kind
Answer: B. Negative operating cash flow warrants further probing.
đ Comprehensive Review
41 Repayment of a long-term loan is an example of a/an:
A. Source of funds / Financing inflow
B. Application of funds / Financing outflow
C. Operating inflow
D. Investing inflow
E. Not relevant to either statement
Answer: B. Loan repayment is an application of funds/Financing outflow.
42 Sale of a long-term investment is classified in the Cash Flow Statement under:
A. Operating Activities
B. Investing Activities
C. Financing Activities
D. None of these
E. Extraordinary Activities
Answer: B. Investment sale is an Investing activity.
43 A provision for doubtful debts created during the year is, under the Indirect Method:
A. Deducted from Net Profit
B. Added back to Net Profit, since it is a non-cash charge
C. Ignored entirely
D. Classified as an Investing outflow
E. Classified as a Financing inflow
Answer: B. Provisions are non-cash charges, added back.
44 Redemption of preference shares is classified under:
A. Operating Activities
B. Investing Activities
C. Financing Activities
D. None of these
E. Extraordinary Activities
Answer: C. Redemption of shares is a Financing activity.
45 Which activity category typically reflects a company's core, day-to-day business performance most directly?
A. Investing Activities
B. Operating Activities
C. Financing Activities
D. Extraordinary Activities
E. None of these
Answer: B. Operating Activities reflect core business performance.
46 Both Funds Flow and Cash Flow Statements are prepared using data from:
A. Two Balance Sheets and related P&L information
B. Only the Auditor's Report
C. Only the Cash Book
D. Only shareholder resolutions
E. Only tax returns
Answer: A. Both use two Balance Sheets and P&L information.
47 A loss on sale of a fixed asset is, under the Indirect Method:
A. Deducted from Net Profit
B. Added back to Net Profit
C. Ignored entirely
D. Classified as a Financing inflow
E. Classified as an Operating inflow directly
Answer: B. A loss on sale is added back, being a non-cash/non-operating item.
48 "Cash Generated from Operations" (before tax) differs from "Net Cash from Operating Activities" by:
A. Depreciation add-back
B. Income tax paid, which is deducted after this point
C. Share capital raised
D. Dividend paid
E. Fixed asset purchases
Answer: B. Tax paid is deducted after "Cash Generated from Operations."
49 Amortisation of an intangible asset, in a Cash Flow Statement (Indirect Method), is treated:
A. The same way as depreciation â added back to Net Profit
B. Deducted from Net Profit
C. Ignored entirely
D. Classified as a Financing outflow
E. Classified as an Investing inflow
Answer: A. Amortisation, like depreciation, is added back as a non-cash charge.
50 For JAIIB purposes, the single most important reason a Cash Flow Statement matters more to a lender than the P&L Account alone is:
A. It reveals whether the business genuinely generates enough cash to service debt
B. It has no relevance to lending decisions
C. It replaces the need for a Balance Sheet
D. It only matters for listed companies
E. It is identical in content to the P&L Account
Answer: A. It reveals genuine cash-based debt-servicing capacity.
Disclaimer: This article is prepared for educational and exam-preparation purposes only. Content reflects AS-3/Ind AS 7 and established practice, as of September 2026. Candidates should cross-check the latest official IIBF syllabus and current notifications before the exam.