Meaning and Concept of Fund

The notion of funds is described by several accountants in different way. The term funds have different meaning according to interpretation of accountants and accounting approaches. Flow of fund means inward and outward movement of funds of an enterprise. Basically, funds denote to working capital and flow means movement and changes. In this regard, flow of funds encompasses movement in working capital items such as current assets and current liabilities. Fund flow analysis is the analysis of flow of fund from current asset to fixed asset or current asset to long term liabilities or vice-versa.

Funds flow statement is an assertion of sources and uses of funds. It describes changes in net working capital between two balance sheet dates. Funds flow statement is prepared in three stages that include schedule of changing in working capital, calculation of funds from operations and statement of fund flow. Net inflows generate surplus cash for fund managers to spend which tend to create demand for stocks and bonds in their preferred sector. On the contrary, net outflows decrease excess cash for fund managers that results in lower demand for stocks and bonds. Consequently, investors can use fund flow information to decide where capital is being invested in terms of asset class or geography. The funds flow statement is helpful in numerous ways such as it is helpful in knowing the sources and uses of funds, suggests the ways in which working capital position can be improved, can be used in planning a sound dividend policy and beneficial in forecasting the flow of funds and in projecting the working capital requirements. It indicates various methods by which funds are obtained during a particular period and the ways in which these funds are employed. In simple words, it is a statement of sources and application of funds. A statement of sources and application of funds is a technical device designed to analyse the changes in the financial condition of a business enterprise between two dates.

Fund flows can offer shareholders with huge information about where capital is being committed around the world. In fund flow, there is all possible information of financial resources which have become available during an accounting period and in the manner these resources are utilized. The statement analyses the changes between opening and closing balance sheet of the period. The flow of fund in company may be conceived as a continuous process. For every use of funds, there must be an offsetting source. In general, the assets of the firm represent the net uses of funds, its liabilities and net worth represent net sources.

Various sources and use of funds:

To summarize, Fund flow statement is considered as an important tool for financial analysis and control. Fund flow analysis serves as a valuable aid to financial manager or creditor in evaluating the use of funds by firm and in explaining how these uses are financed. Future flow can also be evaluated through projected fund statement. This offers the finance manager an efficient method to assess the growth of firm, its resulting financial needs and the best way to finance these needs.

The term ‘funds’ has been defined in a number of ways:

(a) In a narrow sense, it means cash only and a funds flow statement prepared on this basis is called a cash flow statement. Such a statement enumerates net effects of the various business transactions on cash and takes into account receipts and disbursements of cash.

(b) In a broader sense, the term ‘funds’ refers to money values in whatever form it may exist. Here ‘funds’ means all financial resources, used in business whether in the form of men, material, money, machinery and others.

(c) In a popular sense, the term ‘funds’, means working capital, i.e., the excess of current over current liabilities. The working capital concept of funds has emerged due to the fact that total resources of a business are invested partly in fixed assets in the form of fixed capital and partly kept in form of liquid or near liquid form as working capital.

The narrower concept of ‘funds’, i.e., cash or working capital concept, fails to reveal the changes in the total financial resources of a business. Some significant items, such as purchase of building in exchange of shares or payment of bonus in the form of shares, which do not directly affect cash or working capital are not revealed from the analysis based on these concepts.

However, the concept of funds as working capital is the most popular one and in this chapter we shall generally refer to ‘funds’ as working capital and a funds flow statement as a statement of sources and application of funds.

Meaning and Concept of ‘Flow of Funds’:

The term ‘flow’ means movement and includes both ‘inflow’ and ‘outflow’. The term ‘flow of funds’ means transfer of economic values from one asset of equity to another. Flow of funds is said to have taken place when any transaction makes changes in the amount of funds available before happening of the transaction.

If the effect of transaction results in the increase of funds, it is called a source of funds and if it results in the decrease of funds, it is known as an application of funds. Further, in case the transaction does not change funds, it is said to have not resulted in the flow of funds.

According to the working capital concept of funds, the term ‘flow of funds’ refers to the movement of funds in the working capital. If any transaction results in the increase in working capital, it is said to be a source or inflow of funds and if it results in the decrease of working capital, it is said to be an application or out-flow of funds.

Rule:

The flow of funds occurs when a transaction changes on the one hand a non-current account and on the other a current account and vice-versa. When a change in a non-current account e.g., fixed assets, long-term liabilities, reserves and surplus, fictitious assets, etc., is followed by a change in another non-current account, it does not amount to flow of funds. This is because of the fact that in such cases neither the working capital increases nor decreases. Similarly, when a change in one current account results in a change in another current account, it does not affect funds. Funds move from non-current to current transactions or vice-versa only.

In simple language funds move when a transaction affects:

(i) A current asset and a fixed asset, or

(ii) A fixed and a current liability, or

(iii) A current asset and a fixed liability, or

(iv) A fixed liability and current liability; and funds do not move when the transaction affects fixed assets and fixed liability or current assets and current liabilities.

Here we detail about the difference between cash flow analysis and funds flow analysis.

1. The concept of fund refers to actual or notional ‘cash’ under Cash Flow Analysis. But it means either all financial resources or net working capital in Funds Flow Analysis.
2. Cash flow analysis deals with the movement of only actual or notional cash. But funds flow is concerned with all the items constituting funds i.e., net working capital. Cash is one of the components of working capital.
3. Cash flow statements show the causes for the change in cash and bank balances i.e., cash receipts and cash payments alone. Funds flow statement shows the causes for the change in net working capital. It is a flexible device designed to disclose and emphasize all significant changes in the current assets and current liabilities of the firm during the period under study.
4. Cash flow analysis is a tool of short-term financial analysis while the funds flow analysis is comparatively a long-term one.
5. Funds flow statement is in consonant with the actual basis of accounting. But in cash flow statement, the data obtained on accrued basis is converted into cash basis.
6. Funds flow statement tallies the funds generated from various sources with the various uses to which they are put. But cash flow statement starts with the opening cash balance and reaches to the closing cash balance by processing through various sources and uses.
7. In funds flow analysis, the changes in various current assets and current liabilities are shown in a separate statement or schedule of changes in working capital in order to ascertain the net increase or decrease in working capital. But in cash flow analysis, such changes are adjusted to funds from operations in order to ascertain the cash from operations.