transactions affecting the flowy offunds objectives of funds flow statement schedule of changes in working capital funds from operations and funds 4 flow sta limitations haces JCTION chapters, we have discussed the financial statements, n, Trading and Profit and . ial statements, namely, ; 's, namely, the Trading : are certain cases where the company may be flush ough its P&L a/c shows huge losses. Conversely, a company may make substantial profits as Profit and Loss Account, but it may be facing acute cash crunch. Why does this happen? | statements cannot provide any insight into such cases. We need to prepare a Funds Flow 0 ch questions. = We discuss the meaning of fund, transactions affecting the flow of funds, objectives of ement, schedule of changes in working capital, funds from operations and funds flow id finance gener: , int of view of accountants an Fe oe sa In the context of funds flow statement, i t work working capital or ne -apital only.152 Managerial Economics and Financial Analysis CURRENT ASSETS AND CURRENT LIABILITIES LISTED ‘As was already discussed, the current assets are the ass operating cycle or within an accounting year ing cycle or within an year. Table 15.1 indica Ea om Assets Current Current assets Cashinhand Cashat bank Billsreceivable ‘Sundry debtors ‘Marketable/temporary investments ‘Aadvances (Short term) Closing inventory of finished goods/ work in progress/rawmaterials Prepaid expenses 9, Accrued income Current liabilit tes the current assets and current liabilities ts that can be converted into cash within an ties are the liabilities payable within the operat- =] Current liabilities Bank overdraft Sundry creditors Billspayable ‘Outstanding expenses Dividends payable Taxes payable Provision for taxation Provision for dividends Uneamed income OBJECTIVES OF FUNDS FLOW STATEMENT ‘The funds flow statement is prepared to identify different sources and application of funds. In other words, it explains the sources of raising funds and how the samie has been utilised. The funds flow statement answers the following specific questions’ (a) How could the firm pay dividends at a higher rate despite declining profits in the year’? (b) How does the firm have more working capital when the profits have declined drastically? (c) Is the firm solvent or not? (d) How has the company financed its fixed assets? (€) Why does the company find it difficult to pay dividends though it has made good profits? TRANSACTIONS AFFECTING FLOW OF FUNDS. ‘There are certain transactions that influence the flow of funds. In other words, as a result of the transac- tion, there may be either an increase in working capital or a decrease in working capital. There may be ‘some transactions that may not have any effect on the flow of funds, ie., there is neither an increase not a decrease in working capital as a result of the transaction. We can understand the effet of the transac tions on the flow of funds with the following example ‘Suppose the current assets of a company are Rs 3,00,000 and the cu é ppose th 00, in 0,000. The ‘working capital amounts to Rs 1,50,000 (Rs 3,00,000 ~ RS 150.000) ellsFert ony Analysis I Non-current Liabilities te Non-current Assets Nom-current or Long term abilities and Owners’ equity/share holders’ funds 1. Faquity share capital Preference share capital Share premiuen ‘Shares forfeited Reserve fund or General reserve ‘Workmen's compensation fund Capital reserve Depreciation fund or Provision fo depréciation Debentures 10." Long-term loans Discount on issue ofshares and de ee rk aos luc expenditure sch as aderti 0H (a) Purchased goods worth orth Rs 20,000 andi sock of B00ds will increase hy Rs 20 poy es mad By cash. AS a result ofthis transaction the H02K) is increasing by Rs 20.000 sot esa il eens by Rs 20,000, One cusrent set Thus, there will not be any cen et UTTER asset (cash) is decreasing by the same Imchanged and therefore es nes i he total value ofcurentasets, Curent liabilities oie 7 bos ror spacial also remains unchanged at Rs 1,50,000. ed Rs 20, ‘ors. There will be increase in one current asset (ca: € in another current asset (debtors). Here also there will ot be any change in acoig ther flow ed plant and machinery for Rs 1,00,000 and payment is made by issue of debentures. In €, there is no impact on current assets or current liabilites asthe transaction contains only urrent items. [furniture worth Rs 20,000 and payment is made by cheque. Here, there isan increase in sets and a decrease in the bank account. The current assets are reduced to Rs 2,80,000 and liabilities remain at Rs 1,50,000. The working capital will be Rs 1,30,000. Thus, there ease in working capital by Rs 20,000, es for Rs 1,50,000. Here, the share capital increases by Rs 1,50,000 (0 non-curent ¢ Altace Ww will increase from B) and cash will increase by Rs 1,50,000. The current assets now w : : 9,000 to Rs 4,30,000, There is no change in current liabilities, The ‘working capital will be ilities, then there will not be any en also, there will rent i ccurrent lial action contains only current assets or Likewise, if a transaction contains only non-current items, th 1g ca ir stas well asnon-cur i i ion contains both curren! ‘working capital. Only when a transact % pI oe change in working capitalcoe Managerial Economics and Financial Analysis Ll AUnps FLOW STATEMENT Preparation of funds flow statement involves three stagt 1, Statement (or Schedule) of changes in working capital 2. Funds from operations 3. Funds flow statement or statement of sources and application of funds, Impact of Changes in Current Assets and Current Liabilities on Working Capital The statement of changes in working capital will be prepared with the help of current assets and current liabilities. Therefore, we have to identify current assets and current liabilities in the given balance sheets ‘The impact of increase/decrease in current assets and current liabilities on working capital can be under. stood with the following examples * The current assets during the year 2012-13 are Rs 5,00,000 and the current liabilities during the same period are Rs 3,00,000, The working capital during this period is Rs 2,00,000 (i.c., CA~CL Suppose in the year 2013-14, current assets increased to Rs 6,00,000, current liabilities remain- ing the same at Rs 3,00,000. The working capital in this case increases to Rs 3,00,000. When compared to 2012-13, there is an increase in working capital during 2008-9 by Rs 1,00,000. Ifthe current assets in 2013-14 fall to Rs 4,50,000, the current liabilities remaining the same, the ‘working capital will decrease to Rs 1,50,000 and there is a decrease of Rs 50,000 in the working capital, when compared to last year. Let us assume the current assets remain at Rs 5,00,000 in the year 2013-14, but current liabilities decrease from Rs 3,00,000 to Rs 2,25,000, The working capital in this case will increase to Rs 2,75,000 when compared to last year, there is an increase in the working capital by Rs 75,000. Let us assume the current liability increases in the year 2013-14 to Rs 3,25,000, the current asset remaining the same at Rs 5,00,000. Here, the working capital decreases to Rs 1,75,000 and the is a decrease of Rs 25,000 in the working capital, We can, thus, deduce the following rules for the preparation of Statement of Changes in Working Capital (@) Increase in current asset will result in increase in working capital (b) Decrease in current asset will result in decrease in working capital (€) Decrease in current liablity will result in increase in working capital, (d) Increase in current liability will result in decrease in working capital Thus we find a direct relationship between current assets and working capital and an inverse relation ship between current liabilities and working capital Preparation of Statement (or Schedule) of Changes in Working Capital The format of statement of changes in working capital with selected items of current assets and current liabilites is shown as Table 15.3,s Year? Increase in working capa! working cop (Rs) my Ph, working capital - es) ent ts, rent Liabilities er- Sundrycreitors spayable Ee "Working Capital ). tinct ne aa inworking capital {_ Ithere is increase in the current asset ne eee ona es compared to the previous period, then there will be pel column. On the other hand if busters bees enon the Increase in working 5g ‘t , is decrease in the current asset when comy =viot the period, there will be reduction inthe working capital. We put the decreased ee atl oS ee sed amount in the Decrease in | Inthe case ofcuren liabilities, the effect will be opposite, For instance, the decrease in current liability ities Hesult in increase in working capital. The decreased amount will be placed under Ineroce working se 10 capital column. ‘The increase in current liability will result in ‘decrease in working capital. The increased 000 amount willbe placed under Decrease ‘working capital column. oer | ifthe total of the Inereae im workin capital column is higher, we ge increase in working cia) he iy ifthe taal of the Decrease in working capitol cour higher, we get decrease in working capital In other words, the Statement anges in working capital ends with either increase or decreas: in working capital. The statement ‘of changes in working capital is useful for verifying the correctness of rking. the funds flow statement Example1 From the following ales sheet of XYZ Limited, prepare Siatement of hanes working capital 31.12.2012 31.12.2013 “Capital and liabilities Nie) Capital an ig: 6,00,000 7,50,000 ation” Share capital 160,000 1,00,000 0 Sundry creditors 52,000 40,000 Bills Payable, 28,000 62,000 Profit and loss account 340,000. | 952,000 Contd.‘Contd, 459 ee Nabilines ‘undry credit. Bills payable ie 45,000 40,000 el Bank overdran 50,000 Haat ce Outstanding expenses 70,000 75,000 . re Wages ’ pent oO 2,500 Unearned income 3,000 4500 i m tine reise i 2 in working capital 10,000 12,000 0 180,000 | iR0,000 1,35,000 180,000. | 1.80.00 1,59,000 159,000 = Sa — 1,80,000 Kd: ; = Rs 2,20,000 forking capital as on 31.12.2013 = Current assets ~ Current liabilities = 5,35,000 — 1,80,000 = Rs.3,55,000 change in working capital = 3,55,000 ~ 2,20,000 = Rs 1,35,000 v statement contains sources of funds and uses or applications of funds. If the sources of n the uses or applications, then there is increase in working capital. Conversely, if the ‘of funds are more than the sources, then there is decrease in working capital. portant sources of funds is “funds from operations”. It is an internal source arising the business. It is different from net profit of the current year. fons will be calculated by making adjustments of several items to the net profit. All expenses side of the profit ‘and loss account and that do not result in : be added back to the net profit. to Net Profit “The following are some of the items g funds from operations. ecii fon is an expense but there is no Payne ‘outflow of cash for the depreciation expe that will be added back to at of cash for it unlike salaries and se, Hence, Depreciation will be15.10 ‘Managerial Economics and Financial Analysis i.e., gradual writing off of assets such as good will (b) Amortisation of assets Amortisation, do not result in outflow of cash. Hence, they patents, trade markes, copyrights and preliminary expenses will be added back to the net profit Sale procceds of fixed assets will be shown separately inthe funds Jude loss or gain. Hence the loss on sale of fixed assets will \ds from operations. If it is not done so, then it (©) Loss on sale af fixed assets flow statement as a source, Sale proceeds incl be added back to the net profits while calculating fun amounts to error of double counting. Like preliminary expenses written off of loss on. (d) Discount on issue of shares/debentures jed back to the net profit. sale of fixed asset, discount on issue of debentures should be add (e) Interim dividend paid twill be shown separately as “Use of funds’ in the funds flow state ment. Hence, it will be added back to funds flow statement. (Transfer of profit to general reserve 0 is only a transfer entry and it does not result in outfl (g) Premium on redemption preference shares and debentures Redemption of preference shares and debentures including premium, if any, will be shown separately in the funds flow statement as application or use of funds. Hence, premium on redemption of preference shares/debentures will be added reserve fund Transfer of profit to general reserve low of funds. Hence it will be added back to net profit back to net profit, Items to be Deducted from Net Profit (a) Gain on sale of fixed assets Sale proceeds of fixed assets will be shown separately in the funds flow statement as a source. Sale proceeds takes into consideration any gain or loss. Hence gain on sale of fixed assets should be deducted from net profit. Otherwise, it amounts to error of double counting (b) Income from investments Non-operating income such as income from investments will be shown separately in the funds flow statement as a source. Hence income from investments will be added back to net profit, Ina nutshell, ifan item on the expense side of profit and loss account does not result in outflow of cash add back to net profit. If the item is going to be shown separately in the funds flow statement, add back such items to net profit, Ifan item on the credit side of profit and loss account does not result in inflow of cash or is going 10 be shown separately in funds flow statement, deduct the item from net profit Table 15.4 shows a Sample proforma of statement of funds from operations15.13 Amount (Rs) XXX XXX XXX ‘XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX Total uses (b) XXX g in working capital (a)—(b) or Decrease in working capital (b)=(a) XXX Amount (Rs) Application or Uses © Amount (Rs) Purchase of fixed assets XXX Ce ae ~ XXX sa ast ‘Redemption of preference shares XXX "Redemption of debentures XXX Interim dividend paid XXX _ Taxespaid XXX Dividend paid XXX | ncreasein Working capital? XXX Total XXX assuming tha the sources are pester than the uses