In this article we will discuss about:- 1. Introduction to Funds Flow Statement 2. Meaning and Definition of Funds Flow Statement 3. Concept of Flow of Funds 4. External Sources Include of Funds 5. Applications of Funds Flow.
- Introduction to Funds Flow Statement
- Meaning and Definition of Funds Flow Statement
- Concept of Flow of Funds
- External Sources Include of Funds
- Applications of Funds Flow
The technique of funds flow analysis is widely used by the financial analyst, credit granting institution, and financial managers in performance of their jobs. Funds flow statement is also known as statement of sources and uses of funds.
As the name implies, it is a statement which depicts the sources from which funds are obtained and the uses to which they are being put. It is essentially derived from the analysis, of changes which have occurred in assets and equities between two balance sheets period.
According to Foulke, “A statement of sources and applications of fund is a technical device designed to analyze the changes in the financial condition of a business enterprise between two dates.” It is a statement which highlights the underlying financial movements and reflects the changes in the financial position or working capital position in two different dates.
Funds flow statement enables us to study the changes in the financial position of a business enterprise between beginning and ending financial statement dates. It is a statement showing sources and uses of funds for a period of time.
Foulke defines the funds flow statement as “a statement of sources and application of funds is a technical device designed to analyze the changes in the financial condition of a business enterprise between two dates.”
ICWA in glossary of management accounting terms defines funds flow statement as “a statement, either prospective and retrospective, setting out the sources and applications of the funds of an enterprise. The purpose of the statement is to indicate clearly the requirement of funds and how they are proposed to be raised and the efficient utilization and application of the same.”
Funds flow statement is called by various names, such as sources and application of funds, statement of changes in financial position, sources and uses of funds, summary of financial operations, etc.
The term fund has been defined and understood by different experts in different ways. Broadly, the term “fund” refers to all the financial resources of the company. On the other extreme, “fund” refers to cash only. However, the most acceptable meaning of fund is working capital. Working capital is the excess of current assets over current liabilities. Therefore, flow statement funds are referred as working capital.
The flow of funds refers to transfer of economic values from one asset or equity to another. When funds mean working capital, flow of funds refers to movement of funds which cause a change in working capital of the organization. If any transaction results in the increase in working capital, it is said to be source or inflow of funds; and if it results in the decrease of working capital, it is said to be an application or out flow of funds.
Therefore, it should be noted that the flow of funds occurs when a transaction change on account of non-current account and on the other a current account and vice-versa. It emerges from the above that fund flow refers to the changes in the fund (i.e., working capital) by a business transaction.
There is always a flow of fund (change in working capital) by those business transactions that:
(a) Increase the current assets but do not bring any change/increase in current liability or vice versa.
(b) Decrease the current assets but do not bring any decrease in current liabilities and vice versa.
If current assets and current liabilities do change in the same direction and by the same quantum, then only totals of current assets and current liabilities change but the difference between the two, i.e., working capital remains the same and hence there would be no flow of fund in such circumstances.
It is clear from the above discussion that transactions which involve current assets or current liabilities on the one hand and non-current (fixed) assets and/or non-current (long term) liabilities on the other hand will result in flow of funds.
The list of current and non-current accounts is give below in the following tables.
Figure 7.3 depicts flow of funds.
The above diagram clearly indicates that transactions –
(a) Between current assets and non-current assets and non-current liabilities will result in flow of funds.
(b) Between current liabilities and non-current assets and non-current liabilities will result in flow of funds.
(c) Between current assets and current liabilities will not result in flow of funds.
(d) Between non-current assets and non-current liabilities will not result in flow of funds.
The external sources of funds include the following:
(a) Funds from long-term loans – Long-term loans such as debentures, following from financial institutions, will increase the working capital, and therefore, will be flow of funds. However, if debentures are issued in consideration of some fixed assets, there will be no flow of funds.
(b) Sale of fixed assets – Sale of land, buildings, investments, etc., will result in generation of funds.
(c) Funds from increase in share capital – Issue of shares for cash and other current asset results in increase in working capital and hence there will be an inflow of funds.
5. Applications of Funds Flow:
The uses to which funds are put are called application of funds.
Following are some of the purposes for which funds may be used:
(a) Purchase of fixed assets – Purchase of fixed assets, such as land, buildings, plant, machinery, etc., results in decrease in current assets. This is an example of a transaction between current asset and non-current asset. Hence, there will be flow of funds (i.e., current asset, cash reduces and non-current asset, fixed assets increases).
(b) Payment of dividends – Payment of dividends results in decrease of a fixed liability, and therefore, it affects funds.
(c) Payment of fixed liabilities – Payment of debentures and redemption of preference shares result in reduction of working capital, and result in outflow of funds.
(d) Payment of tax liability – Provision for taxation is generally taken as an appropriation of profits and not as an application of funds. But if tax is paid in the current year, it results in flow of funds.
The specimen copy of funds flow statement both in report form and T form are given below: