Year: 2020

Cash management is the process of collecting and managing cash flows. Cash management can be important for both individuals and companies. In business, it is a key component of a company’s financial stability. For individuals, cash is also essential for financial stability while also usually considered as part of a total wealth portfolio.

Individuals and businesses have a wide range of offerings available across the financial marketplace to help with all types of cash management needs. Banks are typically a primary financial service provider for the custody of cash assets. There are also many different cash management solutions for individuals and businesses seeking to obtain the best return on cash assets or the most efficient use of cash comprehensively.

Cash management is the efficient collection, disbursement, and investment of cash in an organization while maintaining the company’s liquidity. In other words, it is the way in which a particular organization manages its financial operations such as investing cash in different short-term projects, collection of revenues, payment of expenses, and liabilities while ensuring it has sufficient cash available for future use.

What is the definition of cash management? In the real world, organizations have strict cash management controls to monitor its inflows and outflows while retaining a sufficient amount in order to take advantage of attractive investments or handle unforeseen liabilities. Efficient management of cash prevents loss of money due to theft or error in processing transactions. Numerous best practices are adopted to enhance management of company’s funds.

This involves shortening of cash collection periods, regular follow ups for collections, negotiation of favorable terms with suppliers allowing delay in payment periods, and preparation of cash flow forecasts. Businesses also use of technology to speed up cash collection process. They must do all of this while maintaining adequate amount of funds to meet daily operations.

Cash is the primary asset individuals and companies use to pay their obligations on a regular basis. In business, companies have a multitude of cash inflows and outflows that must be prudently managed in order to meet payment obligations, plan for future payments, and maintain adequate business stability. For individuals, maintaining cash balances while also earning a return on idle cash are usually top concerns.

In corporate cash management, also often known as treasury management, business managers, corporate treasurers, and chief financial officers are typically the main individuals responsible for overall cash management strategies, cash related responsibilities, and stability analysis. Many companies may outsource part or all of their cash management responsibilities to different service providers. Regardless, there are several key metrics that are monitored and analyzed by cash management executives on a daily, monthly, quarterly, and annual basis.

The cash flow statement is a central component of corporate cash flow management. While it is often transparently reported to stakeholders on a quarterly basis, parts of it are usually maintained and tracked internally on a daily basis. The cash flow statement comprehensively records all of a business’s cash flows. It includes cash received from accounts receivable, cash paid for accounts payable, cash paid for investing, and cash paid for financing. The bottom line of the cash flow statement reports how much cash a company has readily available.

Example

A computer manufacturing company, Techno Ltd., uses supplier Beta & Co. to purchase its core materials. Beta & Co. has the policy of allowing its customers who buy on credit to pay within 30-days period.

At the moment Techno Ltd. has $20 million cash resources available and has to pay $5 million to Beta & Co. after 30-day period for the purchases. However, after 30-day period Techno Ltd. has an investment opportunity requiring use of the full $20 million cash resources.

If the company is able to renegotiate its terms with suppliers allowing 60-day period, the delay in payment will allow the company to benefit by using current funds for the investment and paying suppliers with cash generated next month from other projects. Thus, by properly managing its funds, Techno can take advantage of investment opportunities while maintaining its operations.

Define Cash Management: Cash management means a company’s ability to allocate its funds efficiently in an effort to cover operating expenses, make investments, repay shareholders, and maintain adequate reserves.

• Cash management is the process of managing cash inflows and outflows.
• There are many cash management considerations and solutions available in the financial marketplace for both individuals and businesses.
• For businesses, the cash flow statement is a central component of cash flow management.

Marketable securities are liquid financial instruments that can be quickly converted into cash at a reasonable price. The liquidity of marketable securities comes from the fact that the maturities tend to be less than one year, and that the rates at which they can be bought or sold have little effect on prices.

Marketable Securities are the financial instruments that one can easily buy or sell in the market. The maturities of these financial instruments are usually less than a year. Since they have high liquidity, these investments are good for businesses that need quick cash. Some examples of these financial instruments are government bonds, common stock or certificates of deposit.

Businesses keep their cash in reserves. Such reserves help them in situations when they require cash, like for acquisitions or any unforeseen payment. However, companies do not put all their cash in the reserves. Instead, they invest some in short-term liquid securities to earn interest. This way, the cash not only earns an interest income, but a company can also easily liquidate the investment to meet any future cash need.

The returns on such securities are relatively lower due to their liquidity and the fact that we see them as safe investments. Apple holds a major portion of its wealth in the form of such securities.

Features

• These are highly liquid, meaning one can easily buy and sell these securities.
• Are easily transferable on a stock exchange or otherwise.
• Offer a lower rate of return.
• These are highly marketable as there are active marketplaces where they can be bought or sold.

Types

Marketable securities broadly have two groups marketable debt securities and marketable equity securities.

1. Marketable debt securities

Marketable debt securities are government bonds and corporate bonds. One can trade these on the public exchange and their market price is also readily available. In the balance sheet, all marketable debt securities are shown as current at the cost, until a company realizes a gain or loss on the sale of the debt instrument.

2. Marketable equity securities

Marketable equity securities are common stock and most preferred stock as well. One can also easily trade them on the public exchanges and their market price information is easily available. All marketable equity securities are shown in the balance sheet at either cost or market whichever is lower.

There is also a third type of marketable securities classified further into three categories – money market instruments, derivatives, and indirect investments. Indirect investments include money put into hedge funds and unit trusts.

Derivatives are the investments that are dependent on another security for their value, like futures, options, and warrants.

Money market securities are short-term bonds, like Treasury bills (T-bills), banker’s acceptances and commercial paper. Big financial entities purchase these in massive quantities.

Cash flow is the blood line for any business. Business can survive lack of profits, but cannot survive lack of Cash flow. Managing receivables is one of the most important parts of any Small or large businesses. Hence it is important to know about receivable management solutions.

When we start the business, the thing that looks most difficult is Sales. But once we have done Sales, then we are revealed to more difficult part Receivables. Yes, collecting the due payment from our Buyers is a bigger task, sometimes than the Sales itself.

Receivable Management

There are very few businesses, which have the luxury of receiving money before selling, i.e. Selling for advance payments. Most of the Companies sell their offerings on a credit. Which means that they will collect the money after selling.

Although it looks very simple on the face of it, Managing receivables from Debtors can be a very complex task depending on the nature of our business. As our business grows and as our offering gets complex the process of collecting the payments needs to be designed accordingly.

So the entire process of defining the Credit Policy, Setting Payment Terms, Payment Follow-ups and finally a timely collection of the due payments can be defined as Receivables Management.

Put simply, Receivable Management or Managing Accounts Receivables means collecting the payments due for Sales in a timely manner.  When we sell any services, products or solutions to our clients or customers, they owe us the money. Collecting that money is called Receivables Management.

In Accounting terms Our Customers who owe us money are called as “Sundry Debtors”. Yes, they are called Debtors, because they owe us money.

In India, Management of Receivables is also known as:

• Payment Collection.
• Collection Management.
• Accounts Receivables.

Objectives of Receivable Management

In order to keep business running, we need cash. The whole purpose or objective of Receivables Management is to keep the inflow of cash healthy.

These are receivable management objectives.

• Collect receivables from our sundry debtors.
• Maintain a healthy cash flow for the company, so that it can pay our creditors.
• Have proper Policy for Credit management.
• A working process and mechanism for managing payment follow-ups and timely collection.

Importance of Receivable Management

• Cash flow is always considered as the bloodline of any business organization. Badly managed Receivables can break the company.
• Most of the companies that go bankrupt have Cash flow problems. Companies with a lack of profit can survive, but a lack of cash flow is fatal.
• Working Capital is one of the costliest forms of capital. One of the ways of calculating working capital requirements can be defined as the difference between Sales and Receivables. Bad collections can mean higher working capital requirements. Which means higher interest costs for the company.
• A reliable and predictable Receivables will ensure steady cash flow management of the organization. Amounts receivables with no due dates are useless.

Benefits of Accounts Receivable Management

1. Better Cash Flow

All our Budgets and projections depend on how much we can spend. Predictable cash flow enables us to manage our operations and expansion plans.

2. Lower Working Capital Requirements

Effective receivables management ensures that our Working Capital requirements are kept at a minimum.

3. Lowered Interest costs

Working capital is also fixed capital, which attracts interest. Lower Debtors will reduce our Interest burden.

4. Better Bargaining with Sellers

When we are buying any goods or services, we can bargain mainly on quantity or Payment terms. Having good receivable management provides us with enough cash flow to bargain effectively with our Suppliers.

5. Stop profit leakages

In case of thin margins, just imagine how much more sales we have to do to recover and adjust just one small bad-debt. Nonreceipt or delayed receipt is the biggest profit leakage any company can have.

Importance of Credit Policy in Receivables Management

Having a well-defined credit policy is the first step in having an effective Accounts Receivables Management System. How do we define Credit policy depends on various factors. Some of the points for Credit Policy are listed below:

• Market practice. In the beginning, it is important to follow well-established policies in the market.
• Credit Policy as USP. Many Companies choose to provide more lenient credit policy, much better than the market to get more business.
• Onboarding a new customer should have a strict emphasis on the credit check.
• There should be proper process and policy on when to stop billing to defaulting customers.

Receivable Management Solutions

Deploying software for managing receivables is a very good alternative. A good Receivable Management solution should have the following features or capabilities.

• Mobile App
• Real-time information
• Messages templates for followup
• Store all contracts and related documents in one place
• Monitoring Due and overdue Receivables
• Automated Reminders
• Rule-based Escalation
• Projected Day-wise receivables
• Projected Sales Person wise (or person responsible for collection) receivables
• Area wise or any other criteria for analysis

Planning for a Good system

1. Defining a clear Terms for Payment

Having well defined clear terms of Payments is half the battle won. We might need to have different payment terms based on what we are selling, or quantity or pricing.

Payment terms should be set right into the Invoice that we send and even the PO that we receive from the customer.

Having a down payment (or advance payment) is the best option. Most of the time, we have mythical fear that we will lose the customer if we ask for advance payment.

2. Well Defined Credit Policies

How much credit is to be given and to whom and for how long. Every customer might be thinking that they are different. We need to have a proper Credit Policy to cover every kind of Customer.

3. Setting Responsibilities clearly

• Who will follow up and collect the payment? There should be a very clear cut policy regarding this. Otherwise, its an everlasting buck-passing exercise and ultimately the company has to suffer.
• In most of the SME cases, assigning the receivables responsibilities to the Sales team is a good idea.

4. Proper Credit Check Process in Place

• Having a Credit Policy with no Credit Check in place is absolutely wasteful. Apart from financial documents and Bank details., nowadays there are many credit rating agencies, which provide online Data about the Credit ratings of any particular client.
• It’s always a very good idea to do market research of the customer before providing them with the credit. If the customer is an existing one then just analyzing past history will tell us a lot of actionable information.
• There should be a clear policy regarding When to engage the legal team for Debt collection.

5. Various options for paying

With much online banking and other options, Now the banking has improved a lot. We should provide as many options to our customers to make the payment, like Bank, Cash, Credit Card, Electronic Funds Transfer, Bill discounting, Bill Purchase, etc.

6. Use Technology

• Firstly, Technology can be used in the Credit Check Process, as discussed above.
• More importantly, deploying a software solution, which makes the entire Receivable Management process a lot easier, with automations and reporting.
• While determining any Receivable management solution, make sure that it has a Mobile Application.
• There should be realtime dashboard reporting that we need for smooth operations.

7. Regular Ageing Analysis and Action

• The Customer who goes bad generally doesn’t go bad overnight. They actually show a lot of signs of bad debts, before they go bad. But to catch those signals, we need to have proper aging analysis and monitoring of Receivables.
• Also, there should be clear policy for the next actions. What should the team do, when the Customer does not pay after the bills are overdue?
• Do we have a legal team and process in place which is competent enough to take legal actions?

8. Outsource the Receivable Process

• This is very common, for the BFSI segment, but not for other businesses. There are debt collection agencies, who have specialized processes and capabilities to make the entire process of Receivables as smooth as possible.
• But this is not a bad idea, as this will enable us to focus more on the other functionality of the business like Marketing, Sales, and innovation.

Financial leverage is the use of debt to buy more assets. Leverage is employed to increase the return on equity. However, an excessive amount of financial leverage increases the risk of failure, since it becomes more difficult to repay debt.

The financial leverage formula is measured as the ratio of total debt to total assets. As the proportion of debt to assets increases, so too does the amount of financial leverage. Financial leverage is favorable when the uses to which debt can be put generate returns greater than the interest expense associated with the debt. Many companies use financial leverage rather than acquiring more equity capital, which could reduce the earnings per share of existing shareholders.

Financial leverage has two primary advantages:

1. Enhanced earnings

Financial leverage may allow an entity to earn a disproportionate amount on its assets.

2. Favorable tax treatment

In many tax jurisdictions, interest expense is tax deductible, which reduces its net cost to the borrower.

However, financial leverage also presents the possibility of disproportionate losses, since the related amount of interest expense may overwhelm the borrower if it does not earn sufficient returns to offset the interest expense. This is a particular problem when interest rates rise or the returns from assets decline.

The unusually large swings in profits caused by a large amount of leverage increase the volatility of a company’s stock price. This can be a problem when accounting for stock options issued to employees, since highly volatile stocks are considered to be more valuable, and so create a higher compensation expense than would less volatile shares.

Financial leverage is an especially risky approach in a cyclical business, or one in which there are low barriers to entry, since sales and profits are more likely to fluctuate considerably from year to year, increasing the risk of bankruptcy over time. Conversely, financial leverage may be an acceptable alternative when a company is located in an industry with steady revenue levels, large cash reserves, and high barriers to entry, since operating conditions are sufficiently steady to support a large amount of leverage with little downside.

There is usually a natural limitation on the amount of financial leverage, since lenders are less likely to forward additional funds to a borrower that has already borrowed a large amount of debt.

In short, financial leverage can earn outsized returns for shareholders, but also presents the risk of outright bankruptcy if cash flows fall below expectations.

Financial Leverage Example

Able Company uses $1,000,000 of its own cash to buy a factory, which generates $150,000 of annual profits. The company is not using financial leverage at all, since it incurred no debt to buy the factory.

Baker Company uses $100,000 of its own cash and a loan of $900,000 to buy a similar factory, which also generates a $150,000 annual profit. Baker is using financial leverage to generate a profit of $150,000 on a cash investment of $100,000, which is a 150% return on its investment.

Baker’s new factory has a bad year, and generates a loss of $300,000, which is triple the amount of its original investment.

Similar Terms

Financial leverage is also known as leverage, trading on equity, investment leverage, and operating leverage.

Leverage Ratio

A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt (loans) or assesses the ability of a company to meet its financial obligations. The leverage ratio category is important because companies rely on a mixture of equity and debt to finance their operations, and knowing the amount of debt held by a company is useful in evaluating whether it can pay its debts off as they come due.

What Does a Leverage Ratio Tell You?

Too much debt can be dangerous for a company and its investors. However, if a company’s operations can generate a higher rate of return than the interest rate on its loans, then the debt is helping to fuel growth in profits. Nonetheless, uncontrolled debt levels can lead to credit downgrades or worse. On the other hand, too few debts can also raise questions. A reluctance or inability to borrow may be a sign that operating margins are simply too tight.

There are several different specific ratios that may be categorized as a leverage ratio, but the main factors considered are debt, equity, assets, and interest expenses.

A leverage ratio may also be used to measure a company’s mix of operating expenses to get an idea of how changes in output will affect operating income. Fixed and variable costs are the two types of operating costs; depending on the company and the industry, the mix will differ.

Finally, the consumer leverage ratio refers to the level of consumer debt as compared to disposable income and is used in economic analysis and by policymakers.

Banks and Leverage Ratios

Banks are among the most leveraged institutions in the United States. The combination of fractional-reserve banking and Federal Deposit Insurance Corporation (FDIC), protection has produced a banking environment with limited lending risks.

To compensate for this, three separate regulatory bodies, the FDIC, the Federal Reserve and the Comptroller of the Currency, review and restrict the leverage ratios for American banks. This means they restrict how much money a bank can lend relative to how much capital the bank devotes to its own assets. The level of capital is important because banks can “write down” the capital portion of their assets if total asset values drop. Assets financed by debt cannot be written down because the bank’s bondholders and depositors are owed those funds.

Banking regulations for leverage ratios are very complicated. The Federal Reserve created guidelines for bank holding companies, although these restrictions vary depending on the rating assigned to the bank. In general, banks that experience rapid growth or face operational or financial difficulties are required to maintain higher leverage ratios.

There are several forms of capital requirements and minimum reserve radios placed on American banks through the FDIC and the Comptroller of the Currency that indirectly impacts leverage ratios. The level of scrutiny paid to leverage ratios has increased since the Great Recession of 2007-2009, with the concern about large banks being “too big to fail” serving as a calling card to make banks more solvent. These restrictions naturally limit the number of loans made because it is more difficult and more expensive for a bank to raise capital than it is to borrow funds. Higher capital requirements can reduce dividends or dilute share value if more shares are issued.

A Cash flow analysis is analysis which is prepared by acquiring Cash from different sources and the application of the same for different payments throughout the year.

It is prepared from analysis of cash transactions, or it converts the financial transactions prepared under accrual basis to cash basis.

Cash Flow Analysis is a technique used by businesses to determine the value of overall companies as well as the individual branches of large companies by looking at how much excess cash they produce. They uses the Statement of Cash Flows, a document that shows the actual cash that came in and out of the business during a certain period from investing activities, financing activities, and operational activities, as well as a few other reports.

The information about the amount of resources provided by operational activities or net income after the adjustment of certain other charges can also be obtained from it. The changes in Cash both at the beginning and at the end can also be known with the help of this statement and that is why it is called Cash Flow Statement.

Month after month, many individuals look at their bank and credit card statements and are surprised that they spent more than they thought they did. To avoid this problem, one simple method of accounting for income and expenditures is to have personal financial statements. Just like the ones used by corporations, financial statements provide you with an indication of your financial condition and can help with budget planning.

There are two types of personal financial statements:

• The personal cash flow statement
• The personal balance sheet

Components of Cash Flow

• Income
• Loan EMIs
• Taxes
• Fixed expenses
• Liquid expenses

Objectives of Cash Flow Statement

The primary objective of cash flow statement is to supply the necessary information relating to generation of cash to the users of financial statement. It also highlights the future or prospective cash positions i.e. cash or cash equivalent. The inflows and outflows of cash can be represented with the help of this statement.

(a) Measurement of Cash

Inflows of cash and outflows of cash can be measured annually which arise from operating activities, investing activities and financial activities.

(b) Generating inflow of Cash

Timing and certainty of generating the inflow of cash can be known which directly helps the management to take financing decisions in future.

(c) Classification of activities

All the activities are classified into operating activities, investing activities and financial activities which help a firm to analyse and interpret its various inflows and outflows of cash.

(d) Prediction of future

A cash flow statement, no doubt, forecasts the future cash flows which helps the management to take various financing decisions since synchronisation of cash is possible.

(e) Assessing liquidity and solvency position

Both the inflows and outflows of cash and cash equivalent can be known, and as such, liquidity and solvency position of a firm can also be maintained as timing and certainty of cash generation is known i.e. it helps to assess the ability of a firm to generate cash.

(f) Evaluation of future cash flows

Whether the cash flow from operating activities are quite sufficient in future to meet the various payments e.g. payment of expense/debts/dividends/taxes.

(g) Supply necessary information to the users

A cash flow statement supplies various information relating to inflows and outflows of cash to the users of accounting information in the following ways:

• To assess the ability of a firm to pay its obligations as soon as it becomes due;
• To analyses and interpret the various transactions for future courses of action;
• To see the cash generation ability of a firm;
• To ascertain the cash and cash equivalent at the end of the period.

(h) Helps the management to ascertain cash planning

No doubt, a cash flow statement helps the management to prepare its cash planning for the future and thereby avoid any unnecessary trouble.

Features of Cash Flow Statement

The significant features are:

(i) Cash Flow Statement is very dynamic in character since it records the investment of cash from the beginning of the period to the end of the period.

(ii) It is a periodical statement as it covers a particular period.

(iii) This statement does not recognise matching principles.

(iv) This statement helps to calculate Cash from Operations/Cash Flows from Operational activities.

(v) It exhibits the changes of financial positions relating to operational activities, investing activities and financial activities respectively, by which an analyst can draw his conclusion.

Utility or Importance of Cash Flow Analysis

Cash Flow Statement is particularly useful in short-term planning. In order to meet the various obligations, a firm needs sufficient amount of cash (e.g. payment for expenses, purchase of fixed assets, payments for dividend and taxes etc.).

It helps the financial manager to make a cash flow projection for immediate future taking the data, relating to cash from the past records. As such, it becomes easy for him to know the cash position which may either result in a surplus or a deficit one. However, Cash Flow Statement is an important financial tool for the management to make an estimate relating to cash for the near future.

(a) Helps to make Cash Forecast

Cash Flow Statement, no doubt, helps the management to make a cash forecast for the near future. A projected Cash Flow Statement helps the management about the cash position which is the basis for all operations and, thus, the management sees light relating to cash position, viz. how much cash is needed for a specific purpose, sources of internal and external issues etc.

(b) Helps the Internal Management

It helps the internal management to determine the financial policy to be adopted in future since it supplies information relating to funds, e.g. taking decision about the replacement of fixed assets or repayment of long-term liabilities etc.

(c) Reveal the Cash Position

It is a significant pointer about the movement of cash, i.e. whether there is any increase in cash or decrease in cash and the reasons thereof which helps the management. Moreover, it explains the reasons for a small cash balance even though there is sufficient profit or vice versa.

Besides, the management can compare the original forecast with the actual one in order to understand the trend of movement of cash and the variation therefore.

(d) Reveals the result of Cash Planning

How far and to what extent the cash planning becomes successful, is revealed by the analysis of Cash Flow Statement. The same is possible by making a comparison between the projected Cash Flow Statement/Cash Budget and the actual one, and the measures to be taken.

Importance

Insurance Planning: A proper back up plan is as important as a sound and stable investment plan. Many of you must be having number of insurance policies in your portfolio, but are not sure of the adequacy of insurance cover in that. Some of you have also been bought those policies with a view of saving for future and thus major portion of your cash surplus would be going into those products. Without commenting on the type of products you have bought, what is important for you to understand is the Insurance cover being offered collectively by all those policies.

Asset purchase and Debt management: Having own house or new car has always been one of the most important or thrilling goal for many of you, but buying it on loan needs the understanding of your cash flow position. Though banks will look at it from the repayment capacity of the borrower, financial planning along with will also look on the impact it will bring on other goals too. Debt management and goal planning go hand in hand.

Goal Setting: What is Retirement Planning? It is about managing your current finances and investing the surplus generated in such a way so you can accumulate a decent amount, to lead you to comfortable post-retirement years when you will not be getting monthly income. At that time your savings will be your only source of income generation.

Personal Cash Flow Statement

A personal cash flow statement measures your cash inflows and outflows in order to show you your net cash flow for a specific period of time. Cash inflows generally include the following:

• Salaries
• Interest from savings accounts
• Dividends from investments
• Capital gains from the sale of financial securities like stocks and bonds

Cash inflow can also include money received from the sale of assets like houses or cars. Essentially, your cash inflow consists of anything that brings in money.

Cash outflow represents all expenses, regardless of size. Cash outflows include the following types of costs:

• Rent or mortgage payments
• Gas
• Utility bills
• Groceries
• Entertainment (books, movie tickets, restaurant meals, etc.)

Personal Balance Sheet

A balance sheet is the second type of personal financial statement. A personal balance sheet provides an overall snapshot of your wealth at a specific period in time. It is a summary of your assets (what you own), your liabilities (what you owe), and your net worth (assets minus liabilities).

Assets

Assets can be classified into three distinct categories:

• Large Assets: Large assets include things like houses, cars, boats, artwork, and furniture. When creating a personal balance sheet, make sure to use the market value of these items. If it’s difficult to find a market value, use recent sales prices of similar items.
• Liquid Assets: Liquid assets are those things you own that can easily be sold or turned into cash without losing value. These include checking accounts, money market accounts, savings accounts, and cash. Some people include certificates of deposit (CDs) in this category, but the problem with CDs is that most of them charge an early withdrawal fee, causing your investment to lose a little value.
• Investments: Investments include bonds, stocks, CDs, mutual funds, and real estate. You should record investments at their current market values as well.

Liabilities

Liabilities are merely what you owe. Liabilities include current bills, payments still owed on some assets like cars and houses, credit card balances, and other loans.

Funds flow statement is a statement which discloses the analytical information about the different sources of a fund and the application of the same in an accounting cycle. It deals with the transactions which change either the amount of current assets and current liabilities (in the form of decrease or increase in working capital) or fixed assets, long-term loans including ownership fund.

It gives a clear picture about the movement of funds between the opening and closing dates of the Balance Sheet. It is also called the Statement of Sources and Applications of Funds, Movement of Funds Statement; Where Got—Where Gone Statement: Inflow and Outflow of Fund Statement, etc. No doubt, Funds Flow Statement is an important indicator of financial analysis and control. It is valuable and also helps to determine how the funds are financed. The financial analyst can evaluate the future flows of a firm on the basis of past data.

This statement supplies an efficient method for the financial manager in order to assess the:

(a) Growth of the firm

(b) Its resulting financial needs

(c) To determine the best way to finance those needs

In particular, funds flow statements are very useful in planning intermediate and long-term financing.

Objective of Preparing a Fund Flow Statement

The main purpose of preparing a Funds Flow Statement is that it reveals clearly the important items relating to sources and applications of funds of fixed assets, long-term loans including capital. It also informs how far the assets derived from normal activities of business are being utilized properly with adequate consideration.

Secondly, it also reveals how much out of the total funds is being collected by disposing of fixed assets, how much from issuing shares or debentures, how much from long-term or short-term loans, and how much from normal operational activities of the business.

Thirdly, it also provides the information about the specific utilization of such funds, i.e. how much has been applied for acquiring fixed assets, how much for repayment of long-term or short-term loans as well as for payment of tax and dividend etc.

Lastly, it helps the management to prepare budgets and formulate the policies that will be adopted for future operational activities.

Significance and Importance of Funds Flow Statement

Since traditional reports (i.e. Income Statement/Profit and Loss Account, and Balance Sheet) are not very informative, a financial analyst has to depend on some other report—Funds Flow Statement. In other words, along with the traditional sources of information, some other sources of information are absolutely required in order to take the challenge offered by modern business.

Funds Flow Statement, no doubt, caters to the needs of management. This is because a Funds Flow Statement not only presents the Balance Sheet values for consecutive two years, it also ascertains the changes of working capital—which is a very important indicator.

It not only reveals the source from which additional working capital has been financed but also, at the same time, the use of such funds. Moreover, from a projected funds flow statement the management can easily ascertain the adequacy or inadequacy of working capital, i.e., it helps in decision-making in a number of ways.

The significance and importance of Funds Flow Statements may be summarized as:

(a) Analysis of Financial Statement

The traditional financial statements, viz. Profit and Loss Account and Balance Sheet, exhibit the result of the operation and financial position of a firm. Balance Sheet presents a static view about the resources and how the said resources have been utilized at a particular date with recording the changes in financial activities. But Funds Flow Statement can do so, i.e., it explains the causes of changes so made and effect of such change in the firm accordingly.

(b) Highlighting Answers to Various Perplexing Questions

Funds Flow Statement highlights answers of the following questions:

• Causes of changes in Working Capital;
• Whether the firm sells any Non-Current Asset; if sold, how were the proceeds utilized?
• Why smaller amount of dividend is paid in spite of sufficient profit?
• Where did the net profit go?
• Was it possible to pay more dividend than the present one?
• Did the firm pay-off its scheduled debts? If so, how, and from what sources?
• Sources of increased Working Capital, etc.

(c) Realistic Dividend Policy

Sometimes it may so happen that a firm, instead of having sufficient profit, cannot pay dividend due to lack of liquid sources, viz. cash. In such a circumstance, Funds Flow Statement helps the firm to take decision about a sound dividend policy which is very helpful to the management.

(d) Proper Allocation of Resources

Resources are always limited. So, it is the duty of the management to make its proper use. A projected Funds Flow Statement helps the management to take proper decision about the proper allocation of business resources in a best possible manner since it highlights the future.

(e) As a Future Guide

A projected Funds Flow Statement acts as a business guide. It helps the management to make provision for the future for the necessary funds to be required on the basis of the problem faced. In other words, the future needs of the fund for various purposes can be known well in advance which is a very helpful guide to the management. In short, a firm may arrange funds on the basis of this statement in order to avoid the financial problem that may arise in future.

(f) Appraising of the Working Capital

A projected Funds Flow Statement, no doubt, helps the management to know about how the working capital has been efficiently used and, at the same time, also suggests how to improve the working capital position for the future on the basis of the present problem faced by it, if any.

A Statement of changes in financial position (funds statement) helps us to understands how and why a business enterprise has acquired its resources and what those resources were used for.

The statement of financial position, often called the balance sheet, is a financial statement that reports the assets, liabilities, and equity of a company on a given date. In other words, it lists the resources, obligations, and ownership details of a company on a specific day. You can think of this like a snapshot of what the company looked like at a certain time in history.

This definition is true in the sense that this statement is a historical report. It only shows the items that were present on the day of the report. This is in contrast with other financial reports like the income statement that presents company activities over a period of time. The statement of financial position only records the company account information on the last day of an accounting period.

The objectives of funds statement are:

(i) To summarise the financing and investing activities of the entity, including the extent to which the enterprise has generated funds from operations during the period and

(ii) To complete the disclosure of changes of financial position during the period.

Preparation of Statement of Changes in Financial Position

Concept of Funds

A statement of changes in financial position can be prepared using different concepts of funds as a basis. For instance, statement of changes in financial position may focus on changes in working capital, cash, or total financial resources of a business enterprise.

Accordingly, the preparation of the following types of statement of changes in financial position:-

(i) Statement of changes in working capital, popularly known as Funds Flow Statement or Statement of Sources and Applications of funds.

(ii) Statement of changes in cash popularly known as Cash Flow Statement.

(iii) Statement of changes in Total Financial Resources.

Main Steps in Preparing the Statement:

In order to prepare a statement of changes in financial position on a working capital basis, it is necessary to have balance sheets at two points in time and an income statement covering that span of time.

The steps involved in preparing the statement are as follows:

• Determine the change (increase or decrease) in working capital.
• Determine the adjustments account to be made to net income.
• For each non-current account on the balance sheet, establish the increase or decrease in that account. Analyse the change to decide whether it is a source (increase) or use (decrease) of working capital.
• Be sure the total of all sources including those from operations minus the total of all uses equals the change found in working capital in step 1.

General Rules for Preparing Funds Flow Statement, Working Capital Basis

The following general rules should be observed while preparing funds flow statement:

1. Increase in a current asset means increase (plus) in working capital.
2. Decrease in a current asset means decrease (minus) in working capital.
3. Increase in a current liability means decrease (minus) in working capital.
4. Decrease in a current liability means increase (plus) in working capital.
5. Increase in current asset and increase in current liability does not affect working capital.
6. Decrease in current asset and decrease in current liability does not affect working capital.
7. Changes in fixed (non-current) assets and fixed (non-current) liabilities affects working capital.

Significance of Statement of Changes in Financial Position :Working Capital Basis

A better understanding and analysis of the affairs of a business enterprise requires the knowledge about the movements in assets, liabilities and capital which have taken place during the year and their consequent effect on its financial position. This information is not specifically disclosed by a profit and loss account and balance sheet but can be made available in working capital based funds flow statement.

The funds flow statement is in no way a replacement for the profit and loss account and balance sheet although the information which it contains is a selection, reclassification and summarization of information contained in these two statements. The balance sheet gives a “snapshot” view at a point in time of the sources from which a firm has acquired its funds and the uses which the firm has made of these funds.

The equities side of the balance sheet delineates these sources, and the asset side shows the uses. The income statement is a flow statement; it explains changes that occurred in the profit and loss account by summarizing the increases (revenues) and decreases (expenses) in net profit during the accounting period.

A funds flow statement explains the changes that took place in a balance sheet account or group of accounts during the period between dates of two balance sheets “snapshots.” it shows the manner in which the operations of an enterprise have been financed and in which its financial resources have been used.

It also distinguishes the use of funds for the long-term from the short- term. For example, it distinguishes the use of funds for the purchase of new fixed assets from funds used in increasing the working capital of the company.

Thus, it provides a meaningful link between the balance sheets at the beginning and at the end of a period and profit and loss account for that period. It should be understood, however, that a funds statement does not purport to indicate the requirements of a business for capital.

The concept of working capital is in conformity with normal accrual accounting procedures. Hence, a funs flow statement based on the concept of net working capital fits well with other statements.

Above all, working capital is also a measure of the short-term liquidity of the firm. Therefore, an analysis of factors bringing about a change in the amount of net working capital is useful for decision-making by shareholders, creditors, lenders and management.

Limitation of Statement of Changes in Financial Position: Working Capital Basis

The working capital concept of funds enlarges the problem of valuation because it includes inventory and prepaid items. Thus, the measurement of working capital flows is less precise than for cash.

A fund statement based on the working capital concept is usually a brief presentation, and many significant inter-firm transactions are not disclosed. For example, significant addition to inventories financed by short-term credits would not be shown because the two items are offset in the computation of the net change in working capital.

Furthermore, transactions not affecting working capital, such as the acquisition of plant and equipment by the issuance of equity capital, would not be included in the statement. Therefore, the funds statement in this presentation would not disclose structural changes in the financial relationships in the firm or major changes in policy regarding investments in current assets and short-term financing.