Module-3: Funds Flow Analysis

Dr.Nasa Dhanraj
Assistant professor,
School of commerce
LEARNING OUTCOMES:

• Learning objectives:
• To understand the Concepts of Fund and Funds Flow.
• To know the Current Assets and Current liabilities
• To understand the concept of Funds flow Analysis,
• To know how to prepare Funds Flow Statements.
• MEANING OF FUND: The term fund is generally used to mean the
difference between current assets and current liabilities. In other words,
the term fund stands for net working capital or net current assets.
• Current assets include assets which are acquired with the intention of
converting them into cash during the normal business operations of the
company. They are:
• Cash in hand
• Cash at Bank
• Temporary or marketable investments Trade Debtors
• Bills receivables
• Short term loans
• Stock of Raw Material, Semi-finished goods, Finished goods, W-I-P etc.
• Prepaid expenses
• Accrued Incomes.
• Current liabilities: The term current liabilities are used to describe such
obligations which are paid within one year and which are paid out of current
assets or by creating current liabilities. They are:
• Trade Creditors
• Bills payable
• Bank OD
• Outstanding expenses
• Dividend payable
• Provision against current assets
• Taxation provision
• Income received in advance
• MEANING OF FLOW OF FUNDS
• The term flow means change and therefore the term flow of funds means change in
Funds or change in working capital. In other words, any increase / decrease in
working capital means flow of funds. In business several transactions take place.
Some of these increase the funds while others decrease the funds. Some may not
make any change in the funds position. The movement of funds may be inflow or
outflow. It is said there is:
• Inflow of fund -When the business transaction results in increase in working capital.
• Outflow of fund When the business transaction results in decrease in working
capital.
• No flow fund -When the business transaction results in neither increase nor decrease
in working capital.
• It can be said that only the following transactions may cause the flow of fund.
Transaction between
• One current asset & another noncurrent asset.
• One non-current liability & another current liability.
• One current liability & another noncurrent asset.
• One current asset & another noncurrent liability.
• FUND FLOW STATEMENT
• A funds flow statement is a statement depicting change in working capital.
According to Smith and Brown “A funds flow statement is prepared in
summary form to indicate the changes occurring in terms of financial
condition between two different balance sheet dates”.
• In the words of Robert Anthony “The funds flow statements describe the
sources from which additional funds were derived and the uses to which
these funds were put”.
• Hence funds flow statement is the most useful statement prepared to indicate the
changes in the financial position of a business concern between the opening and
closing balance sheet dates. It is the financial operational statement which
reveals the methods by which a company has been financed. In other words it is
a financial report on the movement of funds (working capital) stating sources
from which funds generate and to which these funds are put into.
• USES OF FUND FLOW STATEMENT
• Emerging as a supplemental financial statement, the funds flow
statement has become an integral part of final accounts. It is a tool of
decision-making, of analysis and of forecasting.
• Tools of Analysis: The funds flow statement analyses and explains
the financial consequences of trading operations. It shows how the
funds were obtained in the past and used. The financial manager can
take corrective actions.
• Tool of working capital management: This statement reveals the
adequacy or otherwise of working capital and the efficiency with
which it is utilised. It enables management to take steps to put surplus
working capital to effective use and also to augment the same in case
it is insufficient.
• Tools of Decision making: The statement keeps management with
regard to such decisions as dividends, capital expenditure and
Budgetary control.
• Tool of forecasting: Financial resources of an enterprise are relatively
scarce in relation to demand. A projected funds flow statement enables
management not merely to utilize the available funds to the optimum
extent, but also to prevent funds being allowed to flow in unprofitable
channels.
• Tools of measuring credit worthiness: It also keeps the creditors and
financial institutions to assess the risk factors involved in granting credit
to a business concern. Shareholders and prospective investors are also
enables to make an assessment of funds available for payment of
dividend and the probable return on their future investment.
• The statement compared with the budget concerned will show to what
extent the resources of the firm were used according to plan and what
extent the utilisation was unplanned.
• LIMITATIONS
• It lacks originality because it is only rearrangement of
data appearing in financial statements.
• It is prepared taking into consideration only fund items
and non-fund items are ignored. As such it is
incomplete and unscientific.
• It reveals some additional information about changes in
working capital. As such, it must be remembered that
funds flow statement is not a substitute of the position
Statement or income statement.
• The information used for the preparation of the fund
flow statement is essentially historical in nature. So it is
not of much use.
• It cannot reveal continuous changes.
• SOURCES OF FUNDS
• Issue of shares for Cash or for any other current asset.
• Issue of Debentures for cash or for any current asset.
• Long term / Medium Term Loans borrowed: Loans borrowed for purchase
of fixed assets or for repayment of existing loan do not form the source of
funds.
• Long term, Medium Term Deposits accepted.
• Sale of Fixed Assets.
• Sale of long-term Investments for cash.
• Refund of Income Tax received.
• Funds from operations (operating or trading profit)
• Non-operating Incomes: Dividend received on Investments, Interest
received on Investments, rent received, gifts received, donations received
etc. are included under this head.
• USES OR APPLICATION OF FUNDS
• Funds lost in operation / Trading Loss: The loss suffered by a business in
the normal & regular business operations is called operating loss.
• Redemption of preference shares in cash or in any other current assets.
• Redemption Debentures in cash.
• Repayment of long terms loans in cash. e. Purchase of long term
Investments.
• Purchase of fixed assets for cash.
• Non-operating expenses- This includes dividend paid on shares, Income
tax paid, Donation given, fines paid etc.
• Funds Flow statement is a method by which we study changes in the
financial position of a business enterprise between beginning and
ending financial statements dates. Hence, the funds flow statement is
prepared by comparing two balance sheets and with the help of such
other information derived from the accounts as may be needed.
Broadly speaking, Funds Flow Statement Format consists of two parts:
• 1. Statement or Schedule of Charges in Working Capital.
• 2. Funds from operations
• 3. Statement of Sources and Application of Funds.
1. Statement or Schedule of Changes in Working Capital:
Working Capital means the excess of current assets over current liabilities.
Statement of changes in working capital is prepared to show the changes in the
working capital between the two balance sheet dates. This statement is prepared
with the help of current assets and current liabilities derived from the two balance
sheets. As, Working Capital = Current Assets – Current Liabilities.
 Statement of Schedule of Changes in Working Capital
Effects on Working Capital
Particulars Previous Year Current Year Amount Amount

Current Assets (CA):

Cash in hand
Cash at bank
Bills Receivable
Sundry Debtors
Temporary investments
Stock/Inventories
Prepaid expensesAccrued Incomes
Total Current Assets

Current Liabilities (CL):

Bills Payable
Sundry Creditors
Outstanding Expenses
Bank Overdraft
Stock-term advances
Dividends PayableProposed
dividendsProvision for taxation
Total Current Liabilities
Working Capital (CA-CL)
Net Increase or Decrease in W.C.
• Funds From Operations or Trading Profits:
Trading profits or the profits from operations of the business are the most
important and major source of funds. Sales are the main source of inflow
of funds into the business as they increase current assets (cash, debtors or
bills receivable) but at the same time funds flow out of business for
expenses and cost of goods sold. Thus, the net effect of operations will be a
source of funds if inflow from sales exceeds the outflow for expenses and
cost of goods sold and vice-versa. But it must be remembered that funds
from operations do not necessarily mean the profit as shown by the profit
and loss account of a firm, because there are many non-fund or non-
operating items which may have been either debited or credited to profit
and loss account.
 Calculating funds from operations:
Adjusted Profit and Loss Account
Rs. Rs.

By Opening Balance (of P & L

To Depreciation & Depletion or A/c).
amortization of fictitious and By Transfers from excess
intangible assets, such as: provisions
Goodwill, Patents, Trade Marks, By Appreciation in the value of
Preliminary Expenses etc fixed assets
.To Appropriation of Retained By Dividends received
Earnings, such as: Transfer to By Profit on sale of fixed or non-
General Reserve, Dividend current assets
Equalization Fund, Sinking Fund, By Funds from Operations
etc. (balancing figure in case debit side
To Loss on sales of any non- exceeds credit side)
current or fixed assets
To Dividends (including interim
dividend)To Proposed Dividend
(if not taken as a current liability)
To Provision for taxation (if not
taken as a current liability)
To Closing balance (of P & L
A/c)
To Funds lost in Operations
(balancing figure, in case credit
side exceeds the debit side)
• Statement of Sources and Application of Funds:
Funds flow statement is a statement which indicates
various sources from which funds (working capital)
have been obtained during a certain period and the use
or applications to which these funds have been put
during that period. Format of Funds Flow Statement are
given below:
Sources Amount Applications Amount
Funds from Operations Funds lost in Operations
Issue of Share Capital Redemption of Preference
Issue of Debentures Share Capital
Raising of long-term loans Redemption of Debentures
Receipts from partly paid shares, Repayment of long-term loans
called upSale of non-current (fixed) assets Purchase of non-current (fixed) assets
Non-trading receipts such as dividendsSale of Purchase of long-term investments
long-term Investments Non-trading paymentsPayment of
Net Decrease in Working Capital DividendsPayment of tax
Net Increase in Working Capital

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Economic Globalization
• Open economy and closed economy