Fund Flow Statement Analysis: The Ultimate

Guide
 Published: 16-Jul-18
Modified: 25-Jan-22
1. What is Funds Flow Statement Analysis?
2. Live Illustration of Fund Flow Statement Analysis
3. Using Fund Flow Analysis to identify syphoning of Funds by Promoters
4. Readers’ Queries about Fund Flow Statement Analysis
Fund flow statement analysis is one of the simplest and basic tools for stock
analysis. Fund flow statement analysis helps investors in identifying the key
areas of utilization of funds for a company during any period along with the
key sources of those funds. Fund flow analysis provides great help to
investors in finding companies, which are giving loans to promoters/related
parties, doing significant capital expenditure, investments in subsidiaries etc.
More importantly, fund flow statement analysis helps the investors in
identifying from where the company got this money, which it is now giving as
loans to promoters/related parties/subsidiaries etc. An investor can easily find
out whether the company is giving away the money, which it earned in profits
or it is taking costly loans from banks and then forwarding this money to
promoters/related parties. If the company is taking loans from banks to give it
to promoters, then an investor would note that the company is doing so at the
cost of public shareholders. This is because, the benefits of the money are
being enjoyed by the promoters, whereas it will be the company (including
public shareholders) who will have to repay the loan & interest to the banks.

Therefore, we believe that the simple exercise of fund flow statement analysis
can help an investor check the shareholder friendliness, integrity and honesty
of the promoters/management within a short period of time. As is usually said,
“To know the truth, follow the money“. Therefore, fund flow analysis is the
tool, which lets investors follow the money and bring to the light a lot of hidden
aspects of the promoter/management decisions. This in turn lets the investor
know whether her interests are being cared for by the company/management.
The current article provides an introduction to fund flow statement analysis
with real-life examples of companies as a live demonstration of the concept.
The article also provides answers to some of the important queries related to
the fund flow analysis asked by investors.

What is Funds Flow Statement Analysis?

The movement of funds in the company’s balance sheet can be assessed by
doing a comparative assessment of different sections of the balance sheet. An
investor should compare the values of every section at the reporting date of
the current year and the previous year and calculate the change in their
values.
1) Equities and Liabilities:

In the liabilities section, any increase in an item means that the company has
received funds (inflow), which need to be paid to external parties like:

 shareholders (equity and reserves),

 lenders (long term debt, short term debt etc),
 vendors (trade payables),
 customers (advances from customers usually part of other current
liabilities)
 employees (leaves, gratuity etc. as part of short term provisions)
Similarly, a decrease in any item in the liability section means that the funds
have gone out (outflow) from the company to third parties to satisfy the
existing liability.

2) Assets:

In the assets section, any increase in items means that the company has
spent funds (outflow) to purchase assets, which would generate cash/funds
inflow in future like:

 Fixed assets (purchase of plant and machinery)

 Long term loans & advances/Non-current investments
(investments in long term financial products, JVs, subsidiaries
etc.)
 Current Investments (investments in short term financial
products)
 Inventory (raw material)
 Trade receivables (payment due from customers)
 Cash & equivalents (bank balance)
 Short term loans & advances (loans to related parties, vendors
etc.)
Similarly, a decrease in any item in the assets section means that the funds
have come into the company (inflow) from third parties by way of sale of
assets or collection of dues from third parties.

This contrasting interpretation of directional change (increase/decrease) in

items in liabilities and assets sections and their impact on funds statement
(inflow/outflow) becomes confusing for many investors. Therefore, it is
essential that the reader spend extra care while interpreting the funds’ flow
analysis.

To understand further, let’s see examples of a few companies where fund-flow

analysis is used to make insightful interpretations.
 Live Illustration of Fund Flow Statement Analysis

Supreme Industries Ltd:

In the screenshot below, the balance sheet items, which have increased in
FY2020 when compared to FY2019 contain a “+” sign in front of them and the
items, which have decreased in FY2020 from FY2019 carry a “-” sign in front
of them. In addition, all the items that indicate a funds inflow have been shown
in “Green” and all the items leading to funds outflow are shown as “Red”.
Therefore, a decrease in assets like “Investment in associate” or “Trade
receivables” have “-” signs as their values have decreased in FY2020 when
compared to FY2019; however, these are shown in “Green” colour as a
decrease in the asset is a fund inflow.
Similarly, a decrease in liabilities like “Trade Payables-Others” or “Other
current liabilities” have “-” sign as their values have decreased in FY2020
when compared to FY2019 and it is shown in “Red” colour as a decrease in
liability is a fund outflow.
FY2020 annual report, page 112:
Please note Supreme Industries Ltd has a large balance sheet size of
thousands of crores Rupees. Therefore, to simplify the analysis, we
have skipped items that have changed by less than ₹5 cr over FY2019-
2020. This is because an analysis of the items showing large changes is
sufficient to give us the main picture of the fund flow analysis with respect to
major sources of funds and major utilization of funds. Leaving out the items
showing minor changes simplifies the analysis whereas only creating small
rounding-off impacts.
The fund-flow analysis depicts that in FY2020, Supreme Industries Ltd has
received funds from the following sources:
  Increase in Borrowings: ₹250 cr
 Other equity (primarily retained earnings): ₹107 cr
 A decrease in Trade receivables: ₹75 cr
 Increase in Finance lease liabilities: ₹30 cr
 Increase in Other financial liabilities: ₹23 cr
 A decrease in Investment in associate: ₹15 cr
 Increase in Deferred tax liabilities: ₹12 cr
 Total: ₹512 cr
Therefore, an investor notices that out of ₹512 cr, a major portion of funds
(₹432 cr) has come from the retained earnings (₹107 cr), borrowings (₹250
cr), and from the collection of receivables due from customers (₹75 cr). (432 =
107+250+75).

So, Supreme Industries Ltd relied primarily on its profits, debt and collections
to raise funds for FY2020.

The analysis also indicates that these funds have been used by the company
in FY2020 in the following manner:

 Increase in Cash & cash equivalents: ₹187 cr

 Increase in Inventories: ₹140 cr
 Increase in Right to use – lease: ₹59 cr
 Increase in Other non-current assets: ₹43 cr
 Purchase of Property, plant & equipment: ₹32 cr
 A decrease in Other current liabilities: ₹27 cr
 A decrease in Trade payables-Others: ₹11 cr
 Increase in Other bank balance: ₹6 cr
 Increase in Other financial assets: ₹5 cr
 Increase in Other current assets: ₹5 cr
 Total: ₹515 cr
An investor notices that the major usages of funds (₹472 cr) by Supreme
Industries Ltd has been in inventories (₹140 cr), plant & machinery (₹32 cr),
cash & investments in bank etc (187+6+5=₹198 cr), other non-current assets
(₹43 cr) and right to use – lease assets (₹59 cr). (472=140+32+198+43+59).

To understand the details of different usages like “other non-current assets”

and “right to use – lease assets” and the purpose of investments in these
items, an investor needs to see their breakup under detailed notes to the
financial statements.

When an investor analyses Supreme Industries Ltd, then she notices that
the increase in “other non-current assets” is primarily due to an increase in
balances with govt. authorities (primarily tax payments = ₹33 cr) and increase
in capital advances (for expansion projects = ₹12 cr).
FY2020 annual report, page 122:
On further analysis, the investor notices that the “right to use – lease” asset is
created due to the adoption of a new accounting standard, IndAS 116 that
reclassifies how a company treats its leased assets like building/office spaces
etc. So, this basically is an investment in leased assets.

FY2020 annual report, page 102:

On transition to Ind AS 116 “Leases”, for these leases, lease liabilities were
measured at the present value of remaining lease payments, discounted at
the Company’s incremental borrowing rate as at April 01, 2019. Right to Use if
measured either at an amount equal to the lease liability adjusted by the
amount of any prepaid or accrued lease payments.
After an overview of the usage of funds indicates that most of the money
raised by Supreme Industries Ltd in FY2020, is kept by it in banks as cash &
investments (₹198 cr), another major portion of the funds was consumed in
inventories (₹140 cr), around ₹45 cr was consumed in payments to govt.
authorities and capital advances, ₹32 cr in investment in plant & machinery
and ₹59 cr in leased assets.

When the investor looks at the above usage of funds along with the major
sources of funds (₹250 cr from borrowings, ₹107 cr from profits/retained
earnings and ₹75 cr from the collection of trade receivables), then the investor
feels that the company has effectively borrowed ₹250 cr from lenders and put
it as cash & investments with banks (₹198 cr).

In light of the above analysis, an investor may conclude that raising money
just to keep it in the bank might not be the best usage of the money.
Nevertheless, it might be that the company plans to use this money early in
the next financial year i.e. FY2021. Therefore, an investor may analyse the
financial position of the company in the coming quarters to understand if it
could use this money that it borrowed and then kept in the bank. If the
company is able to use it in its business, then it is fine otherwise, it may not be
the best strategy to borrow the money and let it lie in the bank.
An investor may read our detailed analysis of Supreme Industries Ltd in the
following article: Analysis: Supreme Industries Ltd
While conducting the fund flow analysis, an investor should focus on the broad
picture. She should focus on what are the large fund inflows and what are the
large fund outflows.

She may find instances where most of the funds have come from
profits/retained earnings and have been used largely for investments in plant
& machinery, which is a healthy pattern. In addition, she may also find
instances where most of the funds came from profits and the company could
not use them for plant & machinery as there is no capital expansion project
underway. Therefore, the company may use them to repay the debt (i.e.
reduction in borrowings on the balance sheet) or may put that in the bank
(increase in cash & equivalents or financial investments).

These are healthy patterns as the funds are generated from genuine business
activities and are used in genuine business usages like capital expenditure,
debt repayments or keeping it as an investment for future use.

On the contrary, an investor may come across fund flow statements where the
company is making losses (i.e. reduction in reserves or other equity) and the
company is raising funds from borrowings and using it to make investments.
The investor should be very cautious if, on detailed analysis, she finds that the
investments may be for taking money out of the company in the form of non-
current investments in promoter-owned entities or loans & advances to related
parties (promoter-owned entities).

Therefore, an investor should do a fund flow statement analysis of each

company before making a final decision. It is a short exercise where attention
to the large inflows and outflows have the potential to unearth management
intentions, integrity and strategic business decisions.

Let us see an example where the fund flow analysis highlighted taking out of
the funds from the company.

Using Fund Flow Analysis to identify syphoning of Funds by

Promoters
Fund flow analysis has the potential of highlighting and early-stage
identification of cases where management uses funds generated from the
company (profits/reserves and debt) for its own benefits in form of loans and
advances to group companies/promoter entities.
The case of Gujarat Automotive Gears Limited (GAGL) is a pertinent example
of funds diversion by the promoter/management, in which the majority
shareholder/promoter/management took out the profits of GAGL and made it
take debt, which GAGL did not need for its operations and used these funds to
give loans to themselves. Promoters of GAGL (HIM Teknoforge Limited) in
turn benefited at the cost of GAGL shareholders.

We highly recommend that an investor should read the detailed analysis of

GAGL in which the funds’ diversion was identified by way of funds flow
analysis in the following article:

Read: Why Management Assessment is the Most Critical Factor in Stock

Investing?
We are providing a section of the fund flow analysis of GAGL below to help
investors understand the immense help provided by fund flow analysis in
the management analysis of any company:

Gujarat Automotive Gears Ltd:

Gujarat Automotive Gears Limited is a small-cap company with a

market capitalization of ₹33 cr. it was established in Baroda in 1973. The
company makes auto and tractor components including transmission gears
and axle shafts. Its products target OEMs and after-markets in India
and sell under the brand name of KAG in India. The company also exports its
products and has United States of America, Germany, Italy, United Kingdom,
Belgium, Egypt, Dubai, Sri Lanka, Singapore, Malaysia, Thailand, Australia
etc. as its overseas markets.
Analysis of Gujarat Automotive Gears Limited revealed that it was a great
business. The following financial performance would reflect that the company
has been showing the picture-perfect image of a good business:

1. Sales had been increasing at a good pace (17%)

2. Profits had been increasing at an even higher pace
3. All the profitability margins were at respectable levels and were
improving further
 4. The company was a debt-free company and
5. Has a cash chest, which was increasing year on year because its
business was a cash cow.
Such a business is always a prize catch to investors and there was no
surprise that in July 2013, the company was acquired by HIM Teknoforge
Limited for ₹21.8 cr. when it purchased the 55% shareholding of erstwhile
promoters.

The company went on with its business as usual under the new promoters
and finished the next year, FY2014, by generating the highest ever sales of
₹29 cr. and profits of ₹5 cr.

However, the investors were in for a surprise when the balance sheet of
Gujarat Automotive Gears Limited on March 31, 2014, was made public and it
showed that the cash holding has reduced from ₹6cr. in FY2013 to ₹1 cr. in
FY2014.

The usage of cash remained a key issue to be found out as the company has
not used it to pay a dividend to its shareholders.

The analysis of the balance sheet on March 31, 2014, showed that Gujarat
Automotive Gears Limited has utilized its existing cash reserves (decline by
about ₹5 cr.) as well as the profits generated in the year FY2014 (increase in
reserves & surplus of about ₹4.5 cr) to provide loans & advance to some
entity (increase by about ₹10 cr.).
The balance sheet of Gujarat Automotive Gears Limited showed that it had
only about ₹3 cr invested in the fixed assets used to make products to
generate its sales & profits, whereas it has given a loan of about ₹10 cr to
some entity. Such kind of loan, which makes loan assets more than fixed
assets reflected that the management of Gujarat Automotive Gears Limited is
finding more value in lending the money than investing it in its core business.

As this business decision of Gujarat Automotive Gears Limited had important

implications, it becomes imperative for any investor to find out who is the
entity to whom this loan has been given.

The investors could find these details in the annual report of Gujarat
Automotive Gears Limited for FY2014, in a section called “Related Party
Transactions”:
Read: How Promoters benefit themselves using Related Party
Transactions
Details in the related party transactions section revealed that Gujarat
Automotive Gears Limited has given a loan (inter-corporate deposit) of ₹9 cr.
to HIM Teknoforge Limited in FY2014.

This action by Gujarat Automotive Gears Ltd meant that it has used its cash
reserves and its entire profits for FY2014 and used it to give a loan to HIM
Teknoforge Limited. HIM Teknoforge Limited is no one but the new promoter
of Gujarat Automotive Gears Limited, who has acquired it in July 2013 by
buying 55% of the shares in the company.

It effectively meant that the new promoter, HIM Teknoforge Limited, within a
few months of acquisition of Gujarat Automotive Gears Limited has used it as
a source of funds (to the extent of ₹9 cr) to serve the purposes of HIM
Teknoforge Limited. I doubt that minority shareholders could have controlled
the loan, which HIM Teknoforge Limited being the management & largest
shareholder, made Gujarat Automotive Gears Limited give to itself.

When an investor continues further with the fund flow statement analysis
of Gujarat Automotive Gears Ltd for the next few years as highlighted in the
article: Why Management Assessment is the Most Critical Factor in Stock
Investing?, then she notices that within the next 3 years, the new promoter,
HIM Teknoforge Ltd, took out more than ₹25 cr. from GAGL, which is even
more than ₹21.8 cr, which it had paid to acquire control of GAGL.

The fund flow statement analysis in the above case shows that GAGL has
effectively funded its own acquisition. This is because, over the next 3 years,
the company has given more money than the acquisition cost to the new
promoter.

Therefore, we believe that along with a very good financial analysis tool, the
fund flow statement analysis is a very important tool for management analysis.
This is because it helps investors understand what is the company doing with
the money; from where it is raising the money and where it is using the
money. Fund flow analysis opens up answers to a lot of such questions, which
are otherwise never resolved for investors.
In addition, investors would note that fund flow statement analysis also
provide inputs about:

whether the debt position of the company is improving or


deteriorating by observing increasing or decreasing debt levels
 whether the receivables position of the company is changing for
better or worse by noticing an increase or decrease in trade
receivables when compared with sales performance
 Status of project progress:
 In case capital work in progress (CWIP) is increasing, it would
mean that the work on the project under implementation is
progressing
 In case CWIP has decreased and net fixed assets (NFA) has
increased, it would mean that most probably the under-
construction project has been completed and has been
transferred from CWIP to NFA
Thus an investor can get multiple useful information points even from the
cursory overview of the summary balance sheet disclosed with financial
results.

In light of the above, we believe that it is essential for every investor to

conduct a fund flow analysis on the companies she analyses for investing. It is
a simple but very effective tool to understand the management intentions,
integrity and shareholder friendliness.

Let us now get further clarifications to the concept of fund flow analysis by
answering important queries asked by investors:

Readers’ Queries about Fund Flow Statement Analysis

Can inventory losses (write-down) lead to erroneously inflated

funds inflow?

Hello sir,

I understand that while calculating cash flow from operations (CFO), we adjust
for the working capital (WC) changes to arrive at CFO.
While analysing the CFO calculation of a commodity type business, I saw that
the changes in the inventory led to the addition of a large amount of inflow in
the CFO and thus heavily inflated the CFO.
The company in question uses commodity as raw material (RM). The raw
material/inventory was valued at very high prices last financial year inventory
closing as the commodity was at its cyclical peak. However, in recent year
commodity prices has corrected to very lows (recent year inventory values).
Therefore, the value of inventory at the end of the year has come down
significantly. I understand that while adjusting for the working capital in CFO
calculation, the reduction in the value of inventory on the balance sheet during
a year is shown as cash inflow.

Therefore, I feel that the losses in the inventory held by the company due to a
decline in the price of the commodity have the potential of inflating the CFO.

So while analysing the fund flow analysis from the balance sheet or cash flow
analysis, how should we consider such changes, which may not be real?

Author’s Response:

Hi,

Thanks for writing to us!

We believe that in such cases of inventory write-down only a case to case

based awareness is sufficient for investors and no change to the general
method of CFO calculation is needed.

Let us see the impacts on both the balance sheet fund flow analysis as well as
the cash flow from operations (CFO) calculation in the case of inventory write-
down.

1) Fund flow statement analysis from the balance sheet:

The decline in inventory will be factored in the profit & loss statement as a
loss/expense, which will reduce the profits and in turn will reduce the retained
earnings (shareholders equity).

If we ignore all other transactions, then in the fund flow analysis, the fund
inflow due to decline in an asset (inventory) will be matched with fund outflow
due to decline in shareholders’ equity (reduction in retained earnings due to
loss in P&L because of inventory write down).

2) Calculation of cash flow from operations (CFO):

The positive entry of change in inventory in the CFO calculation under working
capital changes nullifies the impact of loss recognised in the P&L due to
inventory write down. This positive entry in CFO does not inflate CFO but
cancels out the impact of reduction from loss due to inventory write-down in
the profits.

If we do not add the positive change due to the reduction of inventory in the
CFO, then the CFO will be unduly reduced from inventory write-down losses
(which is a non-cash item).

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

Query 2:

Dear Sir,

I have come across a case where the inventory value has declined to some
extent after purchasing raw materials. In that case, as per fund flow analysis,
decreasing inventory is an inflow. However, in this case, it is not real. How
to approach this situation while doing fund flow analysis? How is it adjusted in
the balance sheet between asset and liability sections?

Author’s Response:

Hi,

Thanks for writing to us!

The purchase of raw material should ideally increase the inventory value in
the profit & loss (P&L) statement. We request you to further elaborate your
query while simultaneously thinking about what other aspects of the balance
sheet or profit & loss statement such a transaction will impact. A write off of
inventory (i.e. a decrease in the assets) will lead to provisions in the P&L
statement and thereby, will decrease the profits and the reserves (a liability).
An increase in inventory (an increase of assets), which is not sold, will
decrease the value of cash by the amount used in the purchase of raw
material (a decrease of assets), which will match the balance sheet.

A decline in the inventory due to the sale of products (a decrease in assets)

will lead to an increase in reserves due to the generation of net profits (an
increase in liability). However, simultaneously, the company will receive cash
from the sale of products/inventory, which will increase the cash & equivalents
more than the decline in inventory (increase in assets) and the balance sheet
will match.

Hope it answers your query.

All the best for your investing journey!

Regards,

Dr Vijay Malik

How to determine equity contribution in Fund Flow Statement

Analysis?

Hi Dr. Malik,

I learned fund flow analysis from your class in Bangalore and I am trying to
implement it for KRBL Ltd. However, I am unable to figure out which number
needs to be used when calculating “Equity”. Should we be using:
1. The difference between last year’s equity and current year’s
equity or
2. PAT for the current year to come to a conclusion?

Any help would be much appreciated 🙂

Regards,

Author’s Response:

Hi,

Thanks for writing to us!

In the case of fund flow analysis, while comparing the balance sheet of two
years, we use the difference in the Equity (equity is the sum of equity capital
and reserves & surplus).

Further advised reading: Understanding the Annual Report of a Company

The change in equity would be a result of retained earnings (PAT – dividend
including dividend distribution tax) and other sources like equity raising due to
IPO/FPO etc. or equity reduction due to buybacks etc.
We cannot use PAT straightaway in fund flow analysis because as mentioned
above, a few other things other than PAT would also impact equity:
like dividend distribution, equity raising or equity reduction etc.
All the best for your investing journey!

Regards

Dr. Vijay Malik

Will the fund inflow and fund outflow be always equal in Fund
Flow Statement?

Dear Dr. Malik,

Many thanks for this article. Though I read the funds flow statement in MBA,
never really applied it while analysing a company. Of course, I used to look at
the movement of assets and liabilities, and check the cash flow statement,
however, putting it down and seeing the movement does help. I have already
incorporated this to a few companies that I am tracking now.

Just one question. When we check the overall figure, should the funds
received be greater than or at least equal to funds used, for us to safely infer
that the company is using the primary source of funds to repay the debt? Have
you come across any instance where the total funds used is greater than the
total funds received? Sorry if this is a stupid question. Thanks a lot.

Author’s Response:

Hi,

Thanks for writing to me! I am happy that you found the article useful.

I am happy that you have started using the funds’ flow in your stock analysis.
It is a very good tool to weed out shareholder unfriendly managements.
The funds’ movement also follows the double-entry system and therefore, the
sources of funds (received) will always be equal to the usage of funds
(usage). In the above example, I have done some rounding off, therefore,
there might be some mismatches in receipts and usage. Otherwise, if you
conduct this exercise by transferring the summary balance sheet in excel,
then usage would match the receipts.

Hope it clarifies your queries! All the best for your investing journey!

Regards,

Vijay

Why the increase in cash & equivalents is a fund outflow?

Hello Sir,

Sir, if there is an increase in cash and cash equivalent of the current asset
section, is it not an inflow of money rather than outflow? How it can be an
outflow of a fund?

Author’s Response:
Hi,

Thanks for writing to me!

Increase in cash & equivalents is an increase in an asset (bank balance),

which can be understood as a cash outflow from the company to the Banks
which leads to an increase in the asset of bank balance. It is similar to the
cash outflow from the company when it buys any investment product.
Investment in such products leads to cash outflow from the company and
resultant increase in holding of the financial/investment product like mutual
funds etc.
Read: Understanding The Annual Report Of A Company
Hope it clarifies your queries!

All the best for your investing journey!

Regards

Vijay