Debre Birhan University

College of Business and Economics

Department of Management, (MBA) Extension Program

Financial and Managerial Accounting Course

Group Assignment: Material Preparation on Cash & Fund Flow Statement

Practices

Prepared by: - Section B, Group 2 Members

1) Semon Worku
2) Rahel
3) Bisrat
4) Girum Lakewu
5) Mikiyas Nigussie
6) Julia

Submitted to: - Sisay Mulate (PhD)

Submission Date 19/2/2022 G.C.

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This material preparation group work is submitted to the course of financial and
managerial accounting. The main purpose of preparing the material is to develop
the ability to prepare such type of material and aware our classmates about the
chapter in detail. In order to do so, the group members devote their time and strive
to address the material objectives.

Material Objectives:
After studying this chapter, you should be able to:
 Understand the purpose of the statement of cash flow and fund flow.
 Analyze the statement of cash and fund flow.
 Prepare a statement of cash flow and fund flow.
 Distinguish among operating, investing, and financing activities of cash flow
statement.

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 Chapter 4
Cash Flow and Fund Flow Statement Practices
Introduction
At the end of each accounting period, preparation and presentation of financial
statements are undertaken with an objective of providing as much information as
possible for the public. The balance sheet presents a snapshot picture of the
financial position at a given point of time and the income statement shows a
summary of revenues and expenses during the accounting period. Though these are
significant statements especially in terms of the principal goals of the enterprise,
yet there is a need for one more statement which will indicate the changes and
movement of funds between two balance sheet dates which are not clearly
mirrored in the balance sheet and income statement. That statement is called as
funds flow statement. The analysis which studies the flow and movement of funds
is called as funds flow analysis. Similarly, one more statement has to be prepared
known as cash flow statement. This requires the doing of cash flow analysis. The
focus of cash flow analysis is to study the movement and flow of cash during the
accounting period.

Concept of Funds
How are funds defined? Perhaps the most ambiguous aspect of funds flow
statement understands what is meant by funds. Unfortunately, there is no general
agreement as to precisely how funds should be defined. To a lay man the concept
of funds means “cash”. According to a few, “funds” means “net current monetary
assets” arrived at by considering current assets (cash + marketable securities +
short term receivables) minus short term obligations. A third view, which is the
most acceptable one, is that concept of funds means “working capital” and in this
study the term “funds” is used in the sense of Working capital.

Flow of Funds
The term “flow” means change and therefore, the term “flow of funds” means
“change in funds” or “change in working capital”. According to manmohan and
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goyal, “the flow of funds” refers to movement of funds described in terms of the
flow in and out of the working capital area. In short, any increase or decrease in
working capital means “flow of funds”. Many transactions which take place in a
business enterprise may increase its working capital, may decrease it or may not
affect any change in it. Let us consider the following examples.

1) Purchased Machinery for Rs.3,00,000: The effect of this transaction is that

working capital decreases by 3,00,000 as cash balance is reduced. This
change (decrease) in working capital is called as application of funds. Here
the accounts involved are current assets (cash a/c) and fixed asset
(machinery a/c).

2) Issue of Share Capital of Rs.10,00,000: This transaction will increase the

working capital as cash balance increases. This change (increase) in working
capital is called as source of funds. Here the two accounts involved are
current assets (cash a/c) and long-term liability (share capital a/c).

3) Notes Payable Drawn by Creditors Accepted for Rs. 30,000: The effect of
this transaction on working capital is nil as it results in increase in notes
payable (a current liability) and decreases the creditors (another current
liability). Since there is no change in total current liabilities there is no flow
of funds.

FUND FLOW STATEMENT

Fund Flow Statement implies a snapshot of the movement of funds, i.e. inflow or
outflows of the firm’s financial assets for a specific period. It represents, “from
where the funds are received and where the funds are utilized” by the company
during a particular period.

The word “fund” refers to a sum of money, which is used to finance the firm’s day
to day operations and acquire assets for the business. The flow of funds represents
the movement of funds, i.e. the change in economic resources, from one asset or
liability to another. In this way, the fund flow statement implies a method of

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analyzing the changes in the firm’s financial position, between two balance sheet
dates.

Fund flow statement is useful in knowing the changes in the structure of assets,
liabilities and capital. It shows whether the sources of funds coincide with its
application and indicates the accuracy of a firm’s financing and investment
decisions. Unlike the cash flow statement, which is prepared on a cash basis, the
fund flow statement is prepared on an accrual basis.

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.

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

 Growth of the firm,

 Its resulting financial needs, and
 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

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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.

The significance and importance of Funds Flow Statements may be summarized

as:

1) 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.

2) 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.

3) Proper Allocation of Resources

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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.

4) 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.

Difference between Fund Flow Statement and Income Statement

Fund Flow Statement
Funds Flow Statement presents
various ways from which funds have
been procured and the applications for
the same.
Funds Flow Statement incorporates
both capital and revenue transactions.
It maintains records from all sources of
funds, irrespective of capital and
revenue.
It is complementary to Income
Statement. It takes help from Income
Statement.
There is no specific format for
preparing a Funds Flow Statement.
Funds Flow Statement reveals the
changes in final position and prescribes
the various ways from which funds
were collected and applied.
Income Statement
Income Statement presents only the
financial results of a firm, i.e. profit or
loss of a firm.
Income Statement records only revenue
items, i.e. operating expenses and
operating incomes, which are required
for ascertaining profit or loss.
Income Statement does not depend on
Funds Flow Statement.
Income Statement is prepared on the
basis of prescribed format.
It does not reveal the changes in
financial positions but presents only the
result of the operation in the form of
profit or loss.

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 It helps the management to take
decisions relating to finance.
It is not mandatory.
It does not recognize non-cash items,
i.e. excludes non-cash items.
It cannot help in such decisions.
It is mandatory.
It includes all non-cash incomes and
non-cash expenses.

Preparation of Fund Flow Statement

Step 1: Preparation of Statement of Changes in Working Capital

Statement of Changes in working capital is a summary that shows the net increase
or decrease in the working capital of the business.
The working capital of the firm increases if there is an increase in the current assets
or decrease in the current liabilities. However, the working capital of the firm
decreases if there is a decrease in the current assets and an increase in the current
liabilities.

Further, there will be no change in the working capital if there is a realization from
debtors or bills receivable or payment made to creditors or bills payable, goods are
sold on credit and goods are purchased on credit.

In this format, there are two parts – current assets and current liabilities. We will
take existing assets and current liabilities from the balance sheet as on March 31,
2019, and March 31, 2018. Then calculate net working capital (after deduction of
current liabilities from current assets) of both years. After that, compare the
networking capital of both years and find out changes in working capital.

In the below example, net working capital as on March 31, 2019, and March 31,
2018, is $12,000 and $5,500 respectively. Therefore for the current year, i.e.,
March 2019, increase in working capital is $6,500.

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Step 2: Determination of Funds from Operations
After preparing the statement of change in working capital, now we need to
prepare a report of funds from operations:

 In this statement, we will take the profit/loss from the profit & loss a/c. But
then, we need to adjust profit/loss.
 We prepare profit & loss accounts on an accrual basis. However, in this non-
cash expenses like depreciation, bad debt, and any expenses written off are
also considered for getting the actual profit or loss.
 We will add back or less, as the case may be, those non-cash expenses, and
we will get the cash profit/loss.
 In the below format, we have assumed the current year’s profit is $20,000.
Then we have identified non-cash items which have been deducted in profit
& loss a/c, which is $3,230, which is now added back in the current year
profit. As a result, a non-operating item added in the profit & loss account of
$120 has been reduced from the current profit.
 After adding and deducting non-cash or non-operating items, we will reach
the position in which fund flow from operations can be derived, i.e.,
$23,110.

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Step 3: Preparation of Fund Flow Statement
After recognizing the funds/loss from operations, fund flow statement is prepared,
which will show the net increase or decrease in the working capital.

 This statement will find out the sources and applications of funds.
 In the above example, we have seen that increases in working capital is
$6,500 (considered as applications of funds), and the fund from an operation
is $23,110 (considered as source of funds).
 Suppose we have issued share capital in the market amounting to $5,000
(considered as source of funds). Arranged source of the funds is used to
enhance working capital and purchase fixed assets.

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Basically, any change in the assets and liabilities may result in the inflows and
outflows of funds, but not always, as in case of depreciation or revaluation of
assets, there is no inflow or outflow of funds. Hence, only those assets or liabilities
will become a part of the statement, which actually leads to the flows of the fund
to/from the business.

CASH FLOW STATEMENT

Cash Flow Statement is a statement that shows flow of cash and cash equivalents
during a given period of time. Cash flow statement shows the net increase or net
decrease of cash and cash equivalents under each activity i.e. operating activity,
investing activity, financing activity. The cash flow statement is one of the three
main financial statements, the others being the income statement and the balance
sheet. Businesses regularly measure their cash flow by preparing a cash flow
statement.

Utility of Cash Flow Analysis

Cash flow analysis yields the following advantages:

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 1. It is very helpful in understanding the cash position of the firm. This would
enable the management to plan and coordinate the financial operations
properly.
2. Since it provides information about cash which would be available from
operations the management would be in a position to plan repayment of
loans, replacement of assets, etc.
3. It throws light on the factors contributing to the reduction of cash balance
inspite of increase in income and vice versa.
4. A comparison of the cash flow statement with the cash budget for the same
period helps in comparing and controlling cash inflows and cash outflows.

Limitations of Cash Flow Analysis

Cash flow analysis is a useful tool of financial analysis. However, it has its own
limitations. These limitations are as under:
1. Cash flow statement cannot be equated with the Income Statement. An
Income Statement takes into account both cash as well as non-cash items
and, therefore, net cash flow does not necessarily mean net income of the
business.
2. The cash balance as disclosed by the cash flow statement may not represent
the real liquid position of the business since it can be easily influenced by
postponing purchases and other payments.

3. Cash flow statement cannot replace the Income Statement or the Funds Flow
Statement. Each of them has a separate function to perform.

Cash flow statement has 3 components. Namely, Operating Activities, Investing

Activities and Financing Activities.

A. Operating Activities
A company's operating activities are the primary means to generate revenue. Cash
flow for operating activities generally means revenues and expenses. Revenue
could come from sales, accounts receivable, refunds, and any settlements.
Expenses could be payments to employees and suppliers, fines, fees, lawsuits, cash
payments for interest, refunds to customers, etc.

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 B. Investing Activities
These are less common sources of cash. Usually they are associated with buying or
selling assets. Cash inflows could come from loan collection, or sales of securities
(from other entities) or long-term assets. Cash outflows could come from buying
fixed assets, debt or equity (from other entities) or loans.

C. Financing Activities
These cash flows come from changes in equity and borrowing. Cash inflows here
could come from a company selling its own equity or proceeds from derivatives.
Cash outflows could come from paying out dividends, debt issuance costs or
outstanding debt.

Income Flows and Cash Flows

The income statement and balance sheet are based on accrual accounting which
was developed based on the principle of matching. The matching principle states
that revenues generated and the expenses incurred to generate those revenues
should be reported in the same income statement. This emphasizes the cause-and-
effect association between revenue and expense.

Many revenues and expenses result from accruals and allocations that do not affect
cash. A company can operate at a profit and continually be short of cash. It can
also generate huge inflows of cash from operations and still report a loss. The
statement of cash flows can explain how these situations might occur. Answers to
these questions cannot be found in the other financial statements.
There are two types of items that cause differences between income flows and
outflows: non-cash income or expense and non-operating income or expense.

An example of a noncash item on the income statement would be depreciation or

amortization. An example of a non-operating item on the income statement would
be a gain on the sale of an asset. These transactions must be reported on a cash
flow statement in order to properly determine the true effect of conducting
business on cash.

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Preparation of Cash Flow Statement

1) Determine the Starting Balance

The first step in preparing a cash flow statement is determining the starting balance
of cash and cash equivalents at the beginning of the reporting period. This value
can be found on the income statement from the same period.

The starting cash balance is necessary if you leverage the indirect method of
calculating cash flow from operating activities. If you instead use the direct
method, this step isn’t required.

2) Calculate Cash Flow from Operating Activities

Next, you need to calculate cash flow from operating activities. This is typically
thought of as the most important section, as it shows how much cash was generated
from a business’s actual operations.

Cash flow from operations can be calculated using either the direct or indirect
method.

Direct Method

The direct method of calculating cash flow from operating activities is

straightforward and involves taking all the cash collections from operations and
subtracting all the cash disbursements from operations. This approach lists all the
transactions that resulted in cash paid or received during the reporting period.

A straightforward presentation of the cash flow from operations section using the
direct method looks somewhat like this:

Cash flow from Operating Activities

Cash receipt customers $1,500,000
Wages and Salaries $450,000
Cash paid to Vendors $525,000

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 Interest Income $175,000
Income before income taxes $700,000
Interest Paid $125,000
Income taxes paid $237,500
Net Cash from Operating Activities $337,500

Indirect Method

The indirect method of calculating cash flow from operating activities requires you
to start with net income from the income statement (see step one above) and make
adjustments to “undo” the impact of the accruals made during the reporting period.
Some of the most common and consistent adjustments include depreciation and
amortization.

It’s important to note: Both the direct and indirect methods will result in the same
number, though the process of calculating cash flow from operations differs.

While the direct method is easier to understand, it’s more time-consuming because
it requires accounting for every transaction that took place during the period. The
indirect method is typically faster and closely linked to the balance sheet, which is
why most companies prefer it. Both methods are accepted by Generally Accepted
Accounting Principles (GAAP) and International Financial Reporting Standards
(IFRS), so you can ultimately decide which method you prefer.

3) Calculate Cash Flow from Investing Activities

After calculating cash flow from operating activities, you need to calculate cash
flow from investing activities. This section of the cash flow statement details cash
flows related to the buying and selling of long-lived assets like property, facilities,
and equipment. Keep in mind that this section only includes investing activities
involving free cash, not debt.

4) Calculate Cash Flow from Financing Activities

The third section of the cash flow statement covers cash inflows and outflows
related to financing activities. This includes cash flows from both debt and equity

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financing; in other words, cash flows associated with raising cash and paying back
debts to investors and creditors.

When using GAAP, this section also includes dividends paid, which may be
included in the operating section if using IFRS standards. Interest paid is included
in the operating section under GAAP but sometimes in the financing section under
IFRS.

5) Determine the Ending Balance

Finally, once cash flows from the three main types of business activities are
accounted for, you can determine the ending balance of cash and cash equivalents
at the close of the reporting period.

The change in net cash for the period is equal to the sum of cash flows from
operating, investing, and financing activities. This value shows the total amount of
cash a company gained or lost during the reporting period. A positive net cash flow
indicates a company had more cash flowing into it than out of it, while a negative
net cash flow indicates it spent more than it earned.

Here’s an example of a fictional company generated using the indirect method.

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Financial Decision-Making

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Whether you’re a manager, entrepreneur, or individual contributor, understanding
how to create and leverage financial statements is essential for making sound
business decisions.

The statement of cash flows is one of the most important financial reports to
understand because it provides detailed insights into how a company spends and
makes its cash. By learning how to create and analyze cash flow statements, you
can make better, more informed decisions, regardless of your position.

Summary
A funds flow statement officially called as statement of changes in financial
position, provides information about an enterprise’s investing and financing
activities during the accounting period. Though there are many concepts of funds,
the working capital concept of funds has been used in this lesson. Flow of funds
results only when there is a cross transaction i.e. only when a transaction involves
a fixed asset or liability and a current asset or liability. The main sources of funds
are: funds from operations, issue of shares and debentures and sale of non-current
assets.

The main uses of funds are repayment of long-term liabilities including redemption
of preference shares and debentures, purchase of non-current assets and payment
of dividends. Funds flow statement helps the financial analyst in having a more
detailed analysis and understanding of changes in the distribution of sources
between two balance sheet dates. In addition to funds flow statement concerns are
also preparing cash flow statement which is the outcome of cash flow analysis.
Cash flow analysis is based on the movement of cash and bank balances and the
cash flow statement is a statement depicting changes in cash position from one
period to another period.

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Reference
1) Zions Bank Business Builder 4, How to prepared a cash flow statement
2) Madhuri T, Dheeraj V, Fund flow statement format,

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