4

Funds Flow Statement

Learning Objectives
After you have studied this chapter, you should be able to:
Understand the meaning and purpose of funds flow statement
Differentiate between funds flow statement and other financial statements i.e. balance
sheet and profit and loss account
Explain the terms funds' and 'flow'
Know the various sources and applications of funds
Prepare Funds Flow Statement
Prepare Statement of Changes in Working Capital

Introduction
Balance Sheet and Profit and Loss Account are the two most important financial statements
which are prepared at the end of the financial year. Balance Sheet (or Position Statement) shows
financial position of an undertaking i.e., assets and liabilities, as on a particular date. The Profit
and Loss Account (or Income Statement) shows the result of operations i.e., profit or loss during
the financial year. No doubt, these two financial statements reveal very useful infromation. But

nese two statements, have a serious limitation i.e. they fail to reveal the changes in assets and
uabilities during the financial year. In the course of business operations, various assets, liabilities
and capital undergo various changes during the financial year. The knowledge of such changes and
edsons of these changes is extremely useful to management of the company. For example, a
company may have issued debentures to raise funds for the purchase of plant and machinery. But
nis infromation is not revealed by Balance Sheet. Therefore, an additional statement should be

Prepared to show the changes in assets, liabilities and owner's equity between dates of two

4.1
 4.2
Managemen Acco
balance sheets. Such a statement is known 'Statement
as
of Changes in Financial Positinue
statement summarises the following: sition'. Th
(a) Changes in assets, liabilities and owner's equity
resulting from financial
ial and
and inuo
investment
transactions during the period; and
(b) Various ways in which the financial resources of the company have been
used durin
etc., to ring
ernod, e.g. to purchase fixed assets like plant and machinery, furniture he rode
debentures, to pay dividends to shareholders and so on. redeen
The Statement of Changes in Financial Position may be prepared on:
() Net working capital basis i.e. Funds Flow Statement; or
(i) Cash basis i.e. Cash Flow Statement. (This is discussed in the next
chapter)
Meaning of Funds Flow Statement
The funds flow statement is an
attempt to report the flow of funds between various assets an
liabilities and owner's capital during an
accounting period. In the words of Smith and Brown
Funds Flow Statement is prepared to indicate in
summary fom, changes (and trends, if
regularly) occurring in items of prepared
financial
position between two different balance sheet dates."
a statement is
prepared to indicate the increases and utilisation of resources of a business Su
an
accounting period. A funds flow statement is also known by various other durna
Statement of Sources and names such a
Funds Generated and
Application of Funds, Where Got, Where Gone Statement' 'Statement
Expended', etc. oj
In order to clearly understand the meaning of Funds Flow
understand the Statement, it is necessary to
meaning of the terms 'Funds' and 'Flow.

Meaning of 'Funds'
The term 'funds' has different
the term funds' means Net meanings. However, for the purpose of funds flow statement
Working
difference between current assets andCapital'
also known as Net Current Assets. It is
defined as te
current liabilities. Thus:
Fund Current Assets -

Current Liabilities.
Illustration 4.1
The following Balance Sheet is given:
Balance Sheet as on 31st March 2011
Liabilities
Assets
Equity Capital
Preference Capital 40,000 Fixed Assets 5 , 0 0 0

General Reserve 10,000

Profit and Loss Account 9,000 Current Assets:
1,200
Current Liabilities Debtors 25,000

S. Creditors Stock 35,000

Bills Creditors 11,000 Cash 2,500

4,200 500
Bank Overdraft
5,800
Prepaid Expenses
Outstanding Expenses 6,800
88,000 88,000
 Fund is calculated as follows:
Total Current Assets 25,000 + 35,000 +2,500+500 =7 63,000
=

Total Curent Liabilities 11,000 + 4,200 + 5,800 +6,800

=

27,800
Fund Current Asset Current Liabilities
=

-63,000 27,800 =35,200

-

In view of this definition of funds, it becomes necessary to understand the terms of 'current
assets, 'current liabilities, Non-current assets, Non-current liabilities.
Current Assets. For accounting purposes, the term current assets means cash and such other
assets which are reasonably expected to be realised in cash or sold or consumed during the normal
operating cycle of the business. Thus curent assets includes the following:
1. Cash and bank balances.
2. Accounts receivable, i.e., debtors and bills receivables.
3. Stocks of raw materials, work in progress and finished goods.
4. Temporary investments or short term investments.
5. Prepayment, e.g., prepaid rent, unexpired insurance, etc.
6. Accrued incomes.
Current Liabilities. The term current liabilities includes all such obligations which are likely to
mature within one year in the normal course of business operations and which are paid out of current
assets or by creating current liabilities. The broad categories of current liabilities are:
1. Accounts payable, i.e., creditors and bills payables.
2. Outstanding expenses, e.g., wages, rent, commission, etc.
3. Bank overdrafts.
4. Incomes received in advance.
5. Dividents payable
6. Provision for doubtful debts
2. Provision for taxation- may be current or non-curent.
non-current.
8. Proposed dividends may be current or
-

for bad and doubtful debts, etc. are also

Provision against current assets, such as, provision
liabilities because such provisions reduce
the amount of current assets.
treated as current
termed as non-curent
not current asset are
Non-Current Assets. All those assets which
are

assets. Examples are :

1. Goodwill.
2. Land and building.
3. Plant and machinery.
4. Furniture.
5. Long term investments.
6. Profit and Loss Account (Debit balance).
2. Preliminary Expenses.
8. Patent rights and trade marks,
debentures.
9. Discount on the issue of shares and

larkina Capital (A-B)

 4.4
Management Accounting
Non-Current Liabilities. This categoryincludes all those liabilities which are not curens
Examples are:
1. Share Capital-
iabilites
equity and preference.
2. Debentures and
long term loans.
3. Profit and Loss Account
(credit balance).
4 Provisions and reserves e.g. capital reserves, general reserves, sinking fund ete
5. Proposed dividends.
6. Share premium account.
2. Share forfeiture accounts.

What is 'Flow of Fund'?

Taking 'fund' in
the sense of net working capital', flow of fund arises when
a transaction is to increase or decrease the amount of the net effect.of
working capital. when a
in the increase
of fund, such a transaction is said to be a source of fund. On thetransaction
other
resuit
transaction results in the decrease of fund, such a transaction is said to hand, if a
be an application of
A transaction that does not
result in either increase or decrease of fund does not result fund
of funds. in the flow

How to judge whether a transaction results in flow of fund or not?

In order to judge as to whether a
particular transaction has resulted in the
change in the net
working capital (or flow of fund), a journal entry should be made and the accounts involved
should be classified into current and
non-current. If all the accounts involved in the
belong to current category, then there is no flow of funds. transaction
in the transaction belong to non-current Similarly, if all the accounts involved
category, then also there is no flow of funds. However, a
transaction will result in the flow of fund
only when one of the accounts involved in the journal
entry belong to current category and another to non-current
On the basis of the above category.
follows
description, the concept of flow of fund can be summarised
as

Category 1. When
transaction involves only current
a
accounts, there is no flow of funds.
Category 2. When
transaction involves only non-current
a
flow of funds. accounts, then also there is no
Category 3. When a transaction involves a current account and a
net working capital increases or non-current account, tne
Given below are some of the examples to
decreases and thus there is a flow of funds.
illustrate the concept of the flow of funds.
CATEGORY 1. Examples of transaction in which
both the accounts involved
current category and thus do not result in flow of
fund. In other words, these belong
have no effect on net working capital. transaction
.
Cash paid to creditors. The Journal
entry will be:
Creditors Account (Current Account). Dr.
To Cash Account (Current Account)
Conclusion-
Conclusion This transaction does not result in the flow of fund because the
accounts involved
accounts (1.e. creditors and cash) belong to the
involved (i.e.
urent accounts. Th
cash account, being9 an 1tem or current asset decreasescategory of current accounnt irent

and creditors, being a cu

iability also decreases. The net effect of this
the amount of net working capital.
transaction therefore will be no change
Funds Flouw Statement 4.5

2. Cash collected from debtors. The journal entry will be:

Cash Account (Current Account) .. Dr.
To Debtors (Current Account)
Conchusion- In this transaction also, both the accounts (cash and debtors) belong to the
category of current accounts and hence there will be no flow of fund. The balance of cash
will increase and that of the debtors will decrease, leaving the amount of net working
capital unchanged. Hence, no flow of funds.
Other examples in this category are as follows:
3. Bills receivable realised Cash A/c (Current) Dr. No flow of
To B/R A/c (Current) fund
4. Received acceptance from customer B/R A/c (Current . Dr. No flow off
To Debtors (Current) fund
5. Purchase on cash or credit basis Purchases A/c (Current) Dr. No flow of
To Cash or creditors (Curent) fund
6. Issued bills payable to creditors Creditors A/c (Current) DI. No flow of
To B/P A/c Current fund

. Discharge of bills payables B/P A/c (Current) A/c Dr. No. flow of
To Cash A/c (Current) fund
8. Sale of short term investments Cash A/c (Current) A/c Dr. No flow of
To Investment A/c (Current) fund

CATEGORY 2. in which both the accounts involved belong to

Examples of transactions
current category and thus do not result in the flow of fund
i.e. it has no effect on
non

networking capital
1. Shares issued to vendors for purchase of land and building. Journal entry will be
Land and Building Account (Non-curent)... Dr.
To Share Capital Account (Non-current)
the amount
Conclusion- As both the accounts involved belong to non-current category,
affected at all thereby keeping the amount
of current asset and current liabilities is not
does not result în the flow of
of working capital unaffected. This transaction therefore,
fund.
Journal entry is :
2. Debentures converted into share capital.
Debentures Account (Non-current) . . Dr.
To Share Capital Account (Non-current)
because both the
not result in the flow of fund
Conclusion- This transaction also does
non-current category and
thus do not affect the amount of
accounts belong to
working capital.
Other examples in category 4 are folloWS
as
No flow
P&LApp. A/c (Non-current)
Dr.

3. Issue of bonus shares of fund

To Sh. Capital A/c (Non-current)
 4.6
Management Accounting
4. Transfer to general reserve P&LApp. A/c (Non-current)
Dr.
General Reserve A/c (Non No flow
current) of fund
5. Writing of goodwill or P&L A/c (Non-current) Dr.
other fictitions asset To Asset etc. (Non current)
No flow
6. of fund
Purchase of building in Building A/c (Non-current) Dr.
exchange of old plant To Plant A/c (Non curent)
No flow
2. Writing off of fund
discount on P &L A/c (Non-current)
Dr.
issue of shares or No flow
debentures To Discount A/c (Non currernt) of fund
8. Purchase of
plant by issue Plant A/c (Non-curent)
of debentures Dr.
No flow
To Debentures A/c (Non
current) of fund
CATEGORY 3. Examples of transactions
Currentcategory and thus result in the flow
involving accounts from both current and non.
of funds i.e. it will
working capital change the amount of net
1.
Machinery purchased for cash. Journal entry is:
Machinery Account (Non-current)... Dr.
To Cash Account
(Current)
Conclusion- In this transaction
account) belongs to the categoryofofpurchase of machinery, one
account
non-current account and the other(i.e., machinery
cash account)
of cash and
belongs to current account category. This account (i.e.,
transaction
ultimately reduces current assets. With this the reduces the amount
decrease thereby net working capital will
2.
resulting in the flow of fund.
Share capital or debentures
Cash Account issued for cash. Journal
(Current) . .Dr. entry is :

To Share
To Share Capital Account (Non-current)
Capital Account or
Debentures A/c
Conclusion-This transaction also results (Non-Current)
in the flow of
current account, will increase fund because cash
thereby
capital which is the other account increasing the amount of current asset.which 1sa
The snare
category will have no involved in this
effect transaction
belongs to
transaction
will therefore be
on current
assets or current
liabilities. non-cune
flow of fund. that net
working capital will increase The net effect o
and it resuts in ue
Other examples in
category 3 are as follows
Transaction
Entry
Effect on
3. Sales of fixed asset on
Cash Working capital
cash or credit Drs. A/c
or
To fixed asset (Curent) Dr. Increase
4. Sale of Long terIm A/c (Non-current)
investments Cash or Bank
A/c
5. Purchase of long term
To
Investments (Current)
(Non current)
Dr. Increase

investments Investments A/c (Non-current)

To cash or Bank Dr. Decrease
6. Raised long term loan
Cash or Bank
A/c (Current)
A/c
To Loan
A/c (Current) Dr. Increase
(Non-current)
 Funds Flow Statement
4.7

7. Redemption of debentures Debentures A/c (Non-current) . . Dr. Decrease

(or preference shares) To Cash (current)
8. Issue of shares at a Cash or Bank A/c (current) Dr. Increase
premium To share capital A/c (Non-current)
To share premium A/c (Non-current)
9. Stock in trade acquired Stock A/c (current) Dr. Increase
by issue of share capital To share capital A/c (Non-curent)
10. Repayment of long term Loan A/c (non-current) Dr. Decrease
loan To Cash or Bank A/c
(current)

CURRENT NON
ASSETS FLOW OF FUNDS CURRENT
ASSETS

|FUNDS
FLOW
FLOW
FUNDS

CURRENT FLOW OF FUNDS

NON -->NO FLOW OF FUNDS
CURRENT
LIABILITIES LIABILTIES FLOW OF FUNDS

EXHIBIT 4.1. Plow of funds

Other Transactions Indirectly Affecting Funds

There are certain accounts of a revenue nature which do not belong to any of the curent or
non current category, e.g., rent paid, insurance premium paid, etc. In the case of such transactions,
ke any other account of a revenue nature, these are transferred to Profit and Loss Account. For
exaimple wages, salaries, rent, commission, etc. are transferred to Profit and Loss Account.
Thereater,
à consolidated entry is made to judge as to whether the transaction has resulted în the flow of
fund or not. This is illustrated below
1. Wages paid. Journal entry is
(a) Wages Account Dr
To Cash Account
(b) Profit and Loss Account... Dr,
To Wages Account
The consolidated entry will be:
(c) Profit and Loss Account (Non-current) ... D
To Cash Account (curent)