Meaning and Definition of Fund Flow Statement

The objects of preparing financial statement with the help of Income statement or, Profit and Loss Account and Balance Sheet is to supply the financial information to the users of financial statements as far as possible No doubt, in order to serve such basic objectives, the Income Statement and the Balance Sheet serve very well.

The Balance Sheet exhibits the financial position at the end of the period through the assets (which show the development of resources in various types of properties) and liabilities (which present how these resources were taken).

The Income Statement, on the other hand, measures the results of the operation at the end of the period, i.e., the change in the owner’s equity as a result of the productive and commercial activities for the period.

Thus, the above two statements are very useful although there are other significant relationship between the two Balance Sheets (opening and closing accounting periods) on which the conventional above two statements cannot throw any light further.

For this purpose, it becomes necessary to know what funds are available during the period and application of such funds along with the profit that has been earned as a result of the business activities. So, in order to know such changes in the financial position, it is necessary to prepare a statement known as Funds Flow Statement which will exhibit such financial information to the users of financial statement.

Concept of Funds Flow Statement:

In order to understand the Funds Flow Statement the meaning of ‘fund’ must be known although the ‘fund’ has got different meaning and interpretation Different accountants/ authors have used the term in different sense, e.g. Cash Fund, Capital Fund, Working Capital Fund etc.

In other words, they have been interpreted in various ways, viz.:

(a) Cash Fund:

Some use the expression ‘the amount of Cash’ in a conservative or narrow sense, as it is synonymous with Cash (i.e., un-deposited cash plus demand deposits at bank). Fund statement is a statement where various types of cash transactions are to be evaluated in the form of ‘Cash Flow Statement’ Some others are of opinion that marketable securities should also be added with cash.

(b) Net Monetary Asset Fund:

There are some other accountants who are of opinion that with the amount of cash. Bank and marketable securities, short-term receiv­ables and secondary cash reserves should also be included with such cash fund.

(c) Capital Fund:

Others use the term ‘Fund’ in a broader sense to mean the total amount of resources employed in the business. It is considered as purchasing or spending power or as all financial resources, arising, as several writers have pointed out, from external rather than internal transactions of the firm. In short, this fund includes the financial resources which affects other than working capital.

(d) Working Capital Fund:

Still others are of the view that the amount of Net Working Capital or the excess of current assets over current liabilities, should be consid­ered as ‘Fund’, particularly for the purpose of preparing Funds Flow Statement. The primary argument against this view is that Stock, Debtors, Short-term investments are considered as equivalent to cash.

And that is why at the time of preparing Funds Flow Statement consolidated changes of different items constituting the Fund are taken into consideration instead of incorporating the changes of each individual item. There is no effect of those transactions which are limited to working capital only in this statement.

Now, we are to see which transactions affect working capital and which do not. Transactions which affect Working Capital

The following items that will cause a change in Working Capital:

A. Increase in Working Capital:

1. Issue of Shares and Debentures;
2. Sale of Fixed Assets or Non-Current Assets;
3. Income from different sources.

B. Decrease in Working Capital:

(i) Redemption of Preference Shares or Debentures;

(ii) Purchase of Fixed Assets or Non-Current Assets;

(iii) Payment of Miscellaneous Expenses;

(iv) Payment of Dividend etc.

Transactions which do not affect working capital:

The following items do not bring about any change in Working Capital:

(i) A shift from one current asset to another current asset by an equal amount or from one current liability to another current liability by an equal amount,

(ii) An increase in current assets by a corresponding equal increase in current liabilities;

(iii) A decrease in current assets by a corresponding equal decrease in current liabilities;

(iv) An increase in non-current assets by a corresponding equal increase in non-current liability or fixed liability;

(v) A decrease in non-current liability by a corresponding equal increase in non- current liability.

Concept of Flow:

When economic values are transferred from one asset to another or from one equity to another or from an asset to an equity or from equity to asset or a combination of any of them, the same is referred to the ‘Flow’ of funds.

When ‘Working Capital Fund’ is considered, this ‘flow’ of funds indicates this movement of funds which are expressed as ‘/low in’ or ‘/low out’. It happens particularly when changes are made from non-current assets account (i.e., fixed asset etc.) to current assets account or vice-versa e.g., when a plant is purchased against cash or preference shares are redeemed etc.

However, the flow of funds is a continuous process i.e., as soon as the funds are used, there must be an off-setting source. It may also be stated that the liabilities and net worth represent net source whereas the assets of a firm represent net use of funds.

Funds Flow Statement:

It 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 a valuable aid to the financial manager and also to a creditor for assessing the uses of funds 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 and

(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.

The significance or importance of funds flow statement can be well followed from its various uses given below:

1. It Helps in the Analysis of Financial Operations:

The financial statements reveal the net effect of various transactions on the operational and financial position of a concern. The balance sheet gives a static view of the resources of a business and the uses to which these resources have been put at a certain point of time. But it does not disclose the causes for changes in the assets and liabilities between two different points of time.

The funds flow statement explains causes for such changes and also the effect of these changes on the liquidity position of the company. Sometimes a concern may operate profitably and yet its cash position may become more and more worse. The funds flow statement gives a clear answer to such a situation explaining what has happened to the profits of the firm.

2. It Throws Light on Many Perplexing Questions of General Interest which Otherwise may be Difficult to be Answered, such as:

(a) Why were the net current assets lesser in spite of higher profits and vice-versa?

(b) Why more dividends could not be declared in spite of available profits?

(c) How was it possible to distribute more dividends than the present earnings?

(d) What happened to the net profit? Where did they go?

(e) What happened to the proceeds of sale of fixed assets or issue of shares, debentures, etc.?

(f) What are the sources of the repayment of debt?

(g) How was the increase in working capital financed and how will it be financed in future?

3. It Helps in the Formation of a Realistic Dividend Policy:

Sometimes a firm has sufficient profits available for distribution as dividend but yet it may not be advisable to distribute dividend for lack of liquid or cash resources. In such cases, a funds flow statement helps in the formation of a realistic dividend policy.

4. It Helps in the Proper Allocation of Resources:

The resources of a concern are always limited and it wants to make the best use of these resources. A projected funds flow statement constructed for the future helps in making managerial decisions. The firm can plan the deployment of its resources and allocate them among various applications.

5. It Acts as a Future Guide:

A projected funds flow statement also acts as a guide for future to the management. The management can come to know the various problems it is going to face in near future for want of funds. The firm’s future needs of funds can be projected well in advance and also the timing of these needs. The firm can arrange to finance these needs more effectively and avoid future problems.

6. It Helps in Appraising the Use of Working Capital:

A funds flow statement helps in explaining how efficiently the management has used its working capital and also suggests ways to improve working capital position of the firm.

7. It Helps Knowing the Overall Creditworthiness of a Firm:

The financial institutions and banks such as State Financial Institutions. Industrial Development Corporation, Industrial Finance Corporation of India, Industrial Development Bank of India, etc. all ask for funds flow statement constructed for a number of years before granting loans to know the creditworthiness and paying capacity of the firm. Hence, a firm seeking financial assistance from these institutions has no alternative but to prepare funds flow statements.