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Prof.

Prakash K Kankure, M Com, CWA(In) MBA

FINANCIAL ANALYSIS –
USING TOOLS SUCH AS
CASH FLOW & FUND FLOW

Presented by Prakash K Kankure


M Com CWA(In) MBA
Funds- An introduction
 Funds – An Introduction: According to Bonniville and
Dewey, ‘funds’ constitute prime importance in starting
and operating any business enterprise. The most
significant of all financial activities is the raising and
management of funds. Financial decisions are those
which concern the generation and flow of funds from
various sources and use of these funds. It is unfortunate
that the term funds flow should be used without
precision in finance. In ordinary parlance, the term
funds means cash, or at least cash equivalent. In
corporate statements, however, the so-called funds
statement usually refers to net working capital.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Funds- An introduction
 The word funds have different connotations giwRta$aR for various
individuals. For the layman, it usually refers to cash; for accountants and
analysis, it most frequently refers to working capital – current assets,
less current liabilities; it may refer to all the sources or to the purchasing
power. For others, it may refer to the net quick or current assets – cash,
temporary investments define the concept of funds. Several definite
concepts to funds might be used, among which are cash, liquid assets,
(cash and near cash assets) , current assets, working capital (current
assets less current liabilities) and total resources. Funds allocation is the
most significant mechanism by which companies determine their future.
In the long term, the ratio of inflows to outflows serves as a
fundamental measure of corporate success, and the creation and control
of these flows is an essential managerial problem.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Funds- An introduction
 The accounting standard states in many countries, the approach to
provide a statement of changes in financial position as a part of
audited accounts is the trend. In India, under existing legal
requirements, companies are under no legal obligation to publish a
statement of changes in financial position along with their financial
statements. However, there is a growing practice to publish such a
statement along with financial statements especially in the case of
companies listed on the stock exchanges and other large
commercial, industrial and business enterprises in public and private
sectors. The statement of changes in the financial position deals with
the funds provided and applied during a period of time. The fund is
any single asset, or any group of assets or any combination of
assets. The three basic concepts of funds, which have influenced the
preparation of funds statements are cash, working capital and all
financial resources.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Funds- An introduction
 The general public views the term funds as cash. This is not
surprising since cash fund is the most common medium of
exchange through which all transactions eventually pass. If
cash alone is to be the basis, then only cash transactions will
have to be reported. As a consequence, the statement of
changes financial position would be a summary of cash
receipts and disbursements. It would simply explain the
change in cash position of a business enterprise during the
period by reflecting flow of cash into and out of the existing
business. The second concept of funds, is the popular and
most commonly followed concept of working capital. It
involves economic resources that can be used to acquire
assets, pay dividends, reduce liabilities and finance etc.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Funds- An introduction
 The working capital definition of funds recognizes that the
significance of most financial transaction is not altered,
though receipt or payment of cash is slightly deferred. In
effect, sales charged to accounts receivable (debtors) or
purchases credited to accounts payable(creditors) are
reported as funds transaction, though they may not give rise
to cash receipts or disbursement by the end of the period
reported. Under this concept, the SCFP is summary of the
means(resources) by which business enterprises accumulate
working capital and the uses to which it is applied. The third
concept defines funds as all financial resources. The use of
this concept of funds eliminates the omission problem
inherent in the cash and working capital concept of funds.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Funds- An introduction
 The word funds is closely related to the normal
decision making process of a business, to accounting
statements, the balance sheet and income statement.
It is related to a time span. There are various
statements which must be compiled by a firm, and
which present information on different aspects of
business. Importance in managerial control should
not be under estimated. Kenneth Midgley and
Ronald G Burns have defined the term funds as one
used in the sense of ‘spending power’; it refers to
the value embedded in assets.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Funds- An introduction
 Funds are usually received into a business initially in the
form of cash, and though a part of this cash may be
used in the purchase of fixed assets, part of it will be
used in the payment of wages and expenses, materials
and/or trading stock directly, depending on the nature
of the business. Funds do not cease to exist merely
because cash has been transformed into assets; they
get embodied in these assets. If goods are sold on
credit, then part of the funds appear in the form of
debtors, and as debtors pay off their debts, funds
revert to cash once again.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Funds- An introduction
 Perry Mason pointed out that without an appropriate
funds statement, the following question cannot be
answered:
 Where are profits gone.
 Why are dividends not larger
 How is it possible to distribute in excess of current
earnings or out of net loss for the period.
 Why have net current assets gone down inspite of the
rise in net income.
 How have the net current assets gone up in spite of the
net loss.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Funds- An introduction
 Why is money borrowed to finance purchase of new plant and
equipment when the required amount is exceeded by the ‘cash flow’
(the sum of net income and depreciation).
 How is the expansion in plant and equipment resulting from a
contraction of operations.
 How are debts are retired.
 What happens to the assets derived from an increase in outstanding
capital stock.
 What happens to the proceeds of the debenture issue.
 How is the increase in working capital financed.
 Does the business tend to be more or less insolvent.
 How has working capital increased in spites of reduced profit dutin
the year.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Concept of “Flow of funds”
 The statement prepared based on the concept of “fund” i.e.
working capital is called “Fund flow statement”
 It means that the movement of funds, may be inflow or
outflow. It is said that there is:
 Inflow of fund: when the business transaction results in
increase in working capital. Such transaction is said to be
source of fund.
 Outflow of fund: when the business transaction results in
decrease in working capital. Such transaction is said to be
application of fund.
 No flow of fund: when the business transaction results in
neither increase or decrease in working capital.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Movement of funds

Inflow of Firm Out flow of


funds funds
---------------
Business
Transactions

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Flow funds when transaction occurs between
current assets and non current accounts

Current Assets and Non


Current Assets

Current Assets and Non


Current Liabilities Flow of funds (inflow or
outflow of funds)
Current Liabilities and
Non Current Assets

Current Liabilities and Flow of Fund Chart


Non Current Liabilities

Prof. Prakash K Kankure, M Com, CWA(In) MBA


When the transaction occurs between non-current account and
current account. It does not involve movement of funds

Current Assets and


Current Liabilities

No flow of funds

Non current assets and


non current liabilities

Prof. Prakash K Kankure, M Com, CWA(In) MBA


When the flow of fund takes place-
circumstances
 Generally, flow of funds takes place when the business
transactions results in change in working capital i.e. when
business transaction involves a current account followed by a
non current account. In order to have the clear idea of the
flow of funds, it is necessary to draw a line of demarcation
between both current and non current accounts.
 Current accounts means current assets and current liabilities
and non-current account mean permanent or fixed assets
and long term or fixed liabilities
 In view of definition of funds, it becomes necessary to
understand the term ‘current assets’ and current liabilities
and Non-current assets, Non Current liabilities.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Current Assets
 Current assets are those assets which can be converted into cash in the normal course
of business within a shorter period- say maximum one year. They are also called
floating or circulating assets because they cannot put to constant use. They are meant
for resale or produced for the purpose of sale i.e. converting them into cash. They
are:
 Cash in Hand.
 Cash at bank
 Temporary or short-term or marketable investments.
 Trade debtors or book debts or accounts receivable
 Bills receivables
 Short term loans and advances
 Inventory or stock of Raw Materials, Semi finished goods, finished goods, Work in
progress and Stores and spare parts.
 Prepaid expenses or expenses paid in advance.
 Accrued incomes or incomes earned but not received.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Current Liabilities
 Current liabilities are those liabilities which are payable within a
shorter period, say one year out of current assets. They are:
 Trade Creditors
 Bills payables
 Bank overdraft
 Outstanding liabilities for expenses
 Dividends payables
 Provision against current assets (e.g. provision for bad and doubtful
debts)
 Provision for Taxation
 Short term Loans from banks and other financial Institutions,
 Income received in advance
 Short public deposits accepted (if any)
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Non-Current Assets
 All assets other than current assets & loans and advances shown in Balance
sheet of a company are referred to as non current assets. They are fixed
assets and fictitious assets viz.
 Goodwill
 Plant and Machinery
 Land & Buildings
 Loose tools
 Patent rights, trademarks
 Motor cars/vehicles.
 Furniture, fixtures & fittings
 Fictitious assets such as Preliminary expenses, issue expenses of shares and
debentures, discount on issue of shares and debentures, Underwriting
commission on the issue of shares and debentures, other deferred revenue
expenses and P&L account debit balance

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Non current Liabilities
 All items other than current liabilities and provisions
shown on the liabilities side of the company’s balance
sheet are termed as non-current liabilities i.e. owned
capital, borrowed capital and other long term loans viz.
 Equity share capital
 Preference share capital
 Reserve & surplus
 Debentures
 Long term loans
 Depreciation reserve/depreciation fund

Prof. Prakash K Kankure, M Com, CWA(In) MBA


How to judge whether 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
transaction belong to current category, then there is no
flow of funds. Similarly, if all the accounts involved in
the transaction belonging to non-current category, then
also there is no flow of funds. However, a transaction
will result in flow of fund only when one of the accounts
involved the journal entry belong to current category
and other non-current category

Prof. Prakash K Kankure, M Com, CWA(In) MBA


How to judge whether transaction
results in flow of fund or not?
 On the basis of above description the concept of flow
of fund can be summarized in three category as below
 Category 1. when a transaction involves only current
accounts, there no flow of funds.
 Category 2. when a transaction involves only non-
current accounts, then also there is no flow funds.
 Category 3. When a transaction involves a current
account and non-current account, the net working
capital increases or decreases and thus three is a flow
of funds.
 Given below are some of examples to illustrate the
concept of the flow of funds.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Category 1. Examples of transaction in which both accounts involved
belong to current category and thus do not result in flow of fund. In
other words, these transaction have no effect on net working capital

 1. Cash paid to creditors: The journal entry will be


 Creditors Account (Current Account) Dr.
To Cash (Current Account)
Conclusion: This transaction does not result in the flow of
fund because both the accounts involved (i.e. creditors
and cash) belong to the category of current accounts.
The cash account, being an item of current assets
decreases and creditors, being current liability also
decreases. The net effect of this transaction therefore
will be no change in the amount of working capital.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Category 1. Examples of transaction in which both accounts involved
belong to current category and thus do not result in flow of fund. In
other words, these transaction have no effect on net working capital

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


 Cash account (Current Account) Dr.
To Debtors (Current Account)
Conclusion: 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 debtors will decrease,
leaving the amount of net working capital unchanged.
Hence, no flow of funds.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Category 1. Examples of transaction in which both accounts involved
belong to current category and thus do not result in flow of fund. In
other words, these transaction have no effect on net working capital

 Other examples in this category are as follows:


No. Transaction Journal Entry Flow
3 Bills receivables realized Cash A/c (Current) Dr. No flow of
To B/R (Current) fund
4 Received acceptance from B/R A/c (Current) Dr. No flow of
customer To Debtors (Current) fund
5 Purchases on cash or credit basis Purchases A/c (Current) Dr No flow of
To Cash or Creditors fund
6 Issued Bills payable to creditors Creditors A/c (Current) Dr No flow of
To Bills Payable (Current) fund
7 Discharge of Bills payable Bills payable (Current) Dr. No flow of
To cash fund
8 Sale of short term investments Cash A/c (Current) Dr No flow of
To Investment (Current). fund
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Category 2. Examples of transaction in which both accounts involved
belong to non-current category and thus do not result in flow of fund. In
other words, these transaction have no effect on net working capital

 1. Shares issued to vendors for purchases of Land


and Building Journal entry will be
 Land & Building A/c(Non-Current) Dr
To Share Capital (Non-Current)
Conclusion: As both the accounts involved being to
non-current category, the amount of current assets
and current liabilities is not affected at all thereby
keeping the amount of working capital unaffected.
This transaction therefore does not result in flow of
fund.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Category 2. Examples of transaction in which both accounts involved
belong to non-current category and thus do not result in flow of fund. In
other words, these transaction have no effect on net working capital

 2. Debentures converted into share capital, Journal


entry is:
 Debentures A/c (Non-current) Dr.
To Equity share capital (Non-current)
Conclusion: This transaction also does not result in the
flow of fund because both the accounts belong to
non-current category and thus do not affect the
amount of working capital.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Category 2. Examples of transaction in which both accounts involved
belong to non-current category and thus do not result in flow of fund. In
other words, these transaction have no effect on net working capital

No. Transactions Journal Entry Flow


3 Issue of Bonus Shares P&L App.A/c (Non Current) Dr No flow of
To Share Capital A/c fund
4 Transfer to general reserve P&L App.A/c (Non Current) Dr No flow of
To General Reserve A/c fund
5 Writing of goodwill or other P & L A/c (Non Current) Dr No flow of
fictitious assets To Assets A/c fund
6 Purchase of building in Building A/c (Non-Current) No flow of
exchange of old plant To Plant A/c (Non Current) fund
7 Writing off discount on issue P & L A/c (Non Current) No flow of
of debentures To Discount (Non Current) fund
8 Purchase of plant by issue of Plant A/c (Non Current) No flow of
debentures To Debentures fund

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Category 3. Examples of transaction in which both accounts involved
belong to current and non-current category and thus result in flow of fund.
In other words, these transaction have effect on net working capital

 1. Machinery Purchased for cash journal entry is


 Machinery Account (Non Current Account) Dr
 To Cash Account ( Current Account)
 Conclusion: In this transaction of purchase of machinery,
one account (i.e. machinery account) belongs to the
category of non current account and the other account
(i.e. cash) belongs to current account category. This
transaction reduces the amount of cash and ultimately
reduces current assets. With this the net working capital
will decrease by thereby resulting in the flow of fund.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Category 3. Examples of transaction in which both accounts involved
belong to current and non-current category and thus result in flow of fund.
In other words, these transaction have effect on net working capital

 2. Share capital or debentures issued for cash, Journal entry


is:
 Cash Account (Current) Dr
 To Share capital or debentures (Non current)
 Conclusion: This transaction also results in the flow of fund
because which is a current account and will increase thereby
increasing the amount of current asset. The share capital
which is the other account involved in this transaction belongs
to non-current category will have no effect on current assets
or current liabilities. The effect of this transaction will
therefore be that net working capital will increase and it
results in the flow of fund.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Category 3. Examples of transaction in which both accounts involved
belong to current and non-current category and thus result in flow of fund.
In other words, these transaction have effect on net working capital

No. Transaction Journal Effect on


Working
capital
3 Sales of fixed assets on Cash or Debtors Account (Current) Dr Increase
cash or credit To Fixed Assets (Non Current)
4 Sale of long term Cash or Bank A/c (Current) Dr Increase
investment To Investment (Non Current)
5 Purchase of Long term Investment A/c (Non-current) Dr Decrease
investments To cash or Bank (Current)
6 Raised long term loan Cash or Bank A/c (Current) Dr Increase
To Loan A/c (Non Current)
7 Redemption of Debentures A/c (Non-Current) Dr Decrease
debentures To Cash
8 Issue of shares at a Cash or Bank A/c(Current) Dr Increase
premium To Share Capital
Prof. Prakash KTo ShareM Premium
Kankure, Com, CWA(In) MBA
Category 3. Examples of transaction in which both accounts involved
belong to current and non-current category and thus result in flow of fund.
In other words, these transaction have effect on net working capital

No. Transaction Journal Effect on


Working
capital
9 Stock in trade acquired Stock A/c (Current) Dr Increase
by issue of share To Share Capital (Non Current)
capital
10 Repayment of long Loan A/c (Non-current) Decrease
term loan To Cash or Bank (Current)q

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Others transactions indirectly affecting
funds
 There are certain accounts of a revenue nature which do not
belong to any of the current or non-current category e.g.
rent paid, insurance premium paid etc. In the case of such
transactions, like any other account of a revenue nature,
these are transferred to Profit and loss account. For
example, wages, salaries, rent, commission etc. are
transferred to Profit and Loss account. Thereafter, a
consolidation entry is made to judge as to whether the
transaction has resulted in the flow of fund or not. This is
illustrated as below:
 1. Wages paid Journal entry is
 Wages Account Dr.
 To Cash Account

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Others transactions indirectly affecting
funds
 (b) Profit and Loss A/c Dr
To Wages A/c
(c) The consolidated entry will be
Profit and loss A/c (Non Current) Dr.
To Cash Account (Current)
Conclusion: Thus this transaction results in flow of fund
because one account belongs to non-current category
and other to current category.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Others transactions indirectly affecting
funds
 2. Depreciation provided on fixed assets. The three
entries are as follows:
(a) Depreciation A/c Dr
To Fixed Assets
(b) Profit & Loss A/c Dr
To Depreciation
(c) Profit & Loss A/c (Non Current) Dr
To Fixed Assets ( Non Current)
Conclusion: As both the accounts involved belong non-
current category, it does not result in the flow of funds.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Flow of funds

Non -
Current
Current
Assets
Assets

Non-
Current
Current
Liabilities
Liabilities

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Illustration: Let us suppose that the balance sheet of XYZ
Co. as on 31st March 2009 was as follows

Capital & Liabilities Rupees Assets & Properties Rupees


Share Capital 3,00,000 Fixed Assets
3000 Eq Shares of Goodwill 50,000
Rs. 100 each
1000, 5% Pref 1,00,000 Land & Buildings 1,00,000
Shares of Rs100 Plant & Machinery 75,000
each Furniture 25,000
General Reserve 50,000 Investments 1,00,000
5% Debentures 1,00,000 Current Assets
Creditors 75,000 Stock 75,000
Bills Payable 25,000 Book Debts 1,25,000
Bills Receivable 30,000
Cash 70,000
6,50,000 6,50,000
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Solution: From the above information, the working capital
of the company may be calculated as follows

Current Assets Rupees Rupees


Stock 75,000
Book Debts 1,25,000
Bills Receivable 30,000
Cash 70,000
3,00,000
Less Current Liabilities
Creditors 75,000
Bills Payable 25,000 1,00,000
Working Capital 2,00,000

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Solution
 In order to know the effect of business transaction on the working
capital (i.e. flow of funds), we should keep in mind that the change in
working capital (i.e. flow of funds) take place when the transaction
involves:
 One current asset and another non-current/fixed asset
 One non-current liability and another current liability
 One current liability and another fixed asset(Non-current asset)
 One current asset and another non-current liability.
 Now let us discuss the effect of each class of transaction on working
capital taking into consideration given in the balance sheet of XYZ
co cited above and working capital of Rs. 200,000 as calculated
from it as the base

Prof. Prakash K Kankure, M Com, CWA(In) MBA


I. When the transaction involves one current asset
and another non-current asset
 Transaction 1. Purchased Machinery for Cash Rs. 30,000
 Journal Entry : Machinery A/c Dr 30,000
To Cash A/c 30,000
 Effect: 1. The value of machinery – non current asset will increase by
Rs. 30,000 i.e. (From Rs. 75,000 to Rs. 105,000)
 Effect 2. The amount of cash – current asset will decrease by Rs.
30,000 (i.e. from Rs. 70,000 to Rs. 40,000) As such, the total value
of current asset will also decrease from Rs. 300,000 to Rs.270,000
but the current liabilities remain the same as they are unaffected.
 Net Effect: Out flow of funds as there is decrease in working capital
by Rs. 30,000 ( i.e. CA –CL = 270,000-100,000 = Rs.170,000)

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Transaction 2. Sale of Buildings for
cash Rs. 50,000
 Journal Entry
 Cash A/c Dr Rs. 50,000
 To Buildings A/c 50,000
 Effects:
 (1) The amount of cash – current asset will increase by Rs. 50,000
(i.e. from Rs. 70,000 to Rs. 120,000) as such, the total value of
current asset will also increase by Rs. 50,000 (i.e. from Rs. 300,000
to Rs. 350,000), but current liabilities remain the same as they are
unaffected.
 (2) the value of buildings  non current asset will decrease by Rs.
50,000(i.e. from Rs. 100,000 to Rs. 50,000)
 Net effect: Inflow of fund as there is increase in working capital by
Rs. 50,000 (i.e. current assets Rs. 350,000 – current liabilities Rs.
100,000)

Prof. Prakash K Kankure, M Com, CWA(In) MBA


II. When the transaction involves one Non current
liability and another current liability
 Transaction : Issue of equity shares to creditors in part settlement of
their claims Rs. 25,000
 Journal Entry
 Creditors A/c Dr. 25,000
 To Equity Share capital Rs. 25,000
 Effects 1. The amount due to creditors current liability will decrease
by Rs. 25,000 (i.e. from Rs. 75,000 to Rs. 50,000) But the total
value of current assets remain the same as they are unaffected.
 Effect 2. The equity share capital  non current liability will
increase by Rs. 25,000 (i.e. from Rs. 300,000 to Rs. 325,000)
 Net Effect: Inflow of fund as there is increase in working capital by
Rs. 25,000 (i.e. Current Assets Rs. 300,000 - Current liabilities
Rs.75,000)

Prof. Prakash K Kankure, M Com, CWA(In) MBA


III. When the transaction involves one current
liability and another non-current asset.
 Transaction: Purchase of furniture on credit Rs. 10,000
 Journal Entry
 Furniture A/c Dr. 10,000
 To Creditors A/c 10,000
 Effect (1) The value of furniture a non-current asset will increase by
Rs. 10,000 (i.e. from Rs.25,000 to Rs.35,000)
 Effect (2) The amount due to creditors  current liability will
increase by Rs. 10,000 (i.e. from Rs.75,000 to Rs. 85,000). But the
total value of current asset will remain the same as they are
unaffected.
 Net Effect: Outflow of fund as there is decrease in working capital
by Rs. 10,000 (i.e. current assets Rs.300,000 – Current liabilities Rs.
1,10,000)

Prof. Prakash K Kankure, M Com, CWA(In) MBA


IV. When the transaction involves one current
asset and another non current liability
 Transaction: Issue of 5% Preference Shares for cash Rs. 50,000
 Journal Entry
 Cash A/c Dr. 50,000
 To 5% Pref. Share Capital A/c 500,000
 Effect (1) The amount of cash-current asset will increase by Rs. 50,000 (i.e.
from Rs. 70,000 to Rs. 120,000) As a result, the total value of current asset
will also increase from Rs. 300,000 to Rs. 350,000. But the amount of
current liabilities remain the same as they are unaffected.
 Effect (2) The liability in respect of 5% Preference Share capital i.e. Non-
current liability will increase by Rs. 50,000 (i.e. from Rs. 100,000 to Rs.
150,000)
 Net Effect: Inflow of fund as there is increase in working capital by Rs.
50,000 (i.e. current assets Rs. 350,000 – Current liabilities Rs. 100,000)

Prof. Prakash K Kankure, M Com, CWA(In) MBA


No flow of fund circumstances
 The flow of funds does not place when a transaction does not result
in changing working capital. Therefore, let us discuss the transactions
having no effect on working capital. And these are
 Involving a current asset and current liability
 Involving a non-current asset and non-current liabilities.
 Involving both items – non current liabilities
 Involving both items – non current assets
 Involving both items – current liabilities and
 Transactions involving both items – non current assets.
 Now let us discuss the effect of each class of transaction on the
working capital into consideration the information given in the
balances sheet of xyz co. cited above and the working capital of
Rs. 200,000 as calculated from it as the base.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


1. Transaction Involving a current asset
and current liability
 Transaction1. Purchased goods on credit Rs. 25,000
 Journal Entry
 Purchase A/c Dr. 25,000
 To Creditors A/c 25,000
 Effect (1) Stock of goods – a current asset will increase by Rs. 25,000 (i.e.
from Rs. 75,000 to Rs. 100,000) resulting in the net increase in the total
value of current assets by Rs. 25,000 (i.e. from Rs. 300,000 to Rs. 325,000)
 Effect(2) Amount due to creditors – current liabilities will also increase by
Rs. 25,000(i.e from Rs. 75,000 to Rs. 100,000), resulting in the net increase
in the total value of current liabilities by Rs .25,000/- (i.e from Rs.100,000
to Rs. 125,000)
 Net Effect: This transaction does not affect the working capital, as such
there is no flow of funds. Because Working capital remains the same
(Rs.200,000) both before and after this transaction ( i.e. before Rs.
300,000 100,000 and after Rs. 325,000 and Rs. 125,000)

Prof. Prakash K Kankure, M Com, CWA(In) MBA


1. Transaction Involving a current asset
and current liability
 Transaction2. Paid cash to Creditors Rs. 25000
 Journal Entry
 Creditors A/c Dr. 25,000
 To Cash A/c 25,000
 Effect(1) Amount due to creditors – a current liability will decrease by Rs.
25,000 (i.e. from Rs. 75,000 to Rs. 50,000) resulting in net decrease in total
value of current liabilities Rs.25000 (i.e. from Rs. 100,000 to Rs. 75,000)
 Effect (2) Amount of cash – a current asset will also decrease by Rs.25,000
(i.e. from Rs.70,000 to 45,000) resulting in the net decrease in total value
of current asset by Rs. 25,000(i.e. from Rs.300,000 to Rs. 275,000)
 Net Effects: This transaction does not affect the working capital, as such
there is no flow of funds. Because working capital remains the same before
and after this transaction (i.e. before Rs. 300,000-100,000 and after
Rs.275,000- Rs.75,000)

Prof. Prakash K Kankure, M Com, CWA(In) MBA


1. Transaction Involving a current asset
and current liability
 Transaction3. Borrowed Rs.30,000 as a short term loan from a director of
the company.
 Journal entry
 Cash A/c Dr. 30,000
 To Directors Loan A/c 30,000
 Effect(1) Amount of cash a current asset will increase by Rs. 30,000 (i.e.
from Rs. 70,000 to Rs. 100,000) resulting in the net increase in the total
value of current assets by Rs. 30,000(i.e. from Rs.300,000 to Rs. 330,000)
 Effect(2) Directors Loan accounts – a current liability will also increase by
Rs. 30,000 resulting in net increase in the total value of current liabilities by
Rs. 30,000
 Net Effect: This transaction do not affect the working capital. As such, there
is no flow of funds. Because the working capital remains the same both
before and after this transaction (i.e. before Rs. 300,000 – Rs.100,000 and
after Rs. 330,000 – Rs. 130,000)

Prof. Prakash K Kankure, M Com, CWA(In) MBA


II. Transaction involving a non-current
asset and a non current liability.
 Transaction: Purchase of machinery for Rs.100,000 by the issue
of equity shares.
 Journal entry. Machinery A/c Dr.100,000
 To Eq Share Capital 100,000
 Effect(1) Value of machinery, a non-current asset will increase
by Rs. 100,000 (i.e. from Rs.75,000 to Rs. 175,000)
 Effect(2) Amount of equity share capital, a non-current liability
will also increase by Rs. 100,000 (i.e. from Rs. 300,000 to Rs.
400,000)
 Net Effect: This transaction do not affect working capital as it
has no influence either on current assets or on current liabilities.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
III. Transaction involving both non
current liabilities.
 Transaction1. Redemption of 5% Debentures by issue of equity
shares Rs.50,000
 Journal Entry
 5% Debentures A/c Dr. 50,000
 To Equity Share capital 50,000
 Effect (1) 5% debenture,, a non current liability will decrease by Rs.
50,000 (i.e. from Rs. 100,000 to Rs.50,000)
 Effect (2) Amount of equity share capital, another non-current
liability will increase by Rs. 50,000 (i.e. from Rs. 300,000 to Rs.
350,000)
 Net Effect: This transaction does not affect the working capital as it
has no influence either on current assets or on current liabilites.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


III. Transaction involving both non
current liabilities.
 Transaction 2. Transfer Rs. 25,000 to general reserve fund.
 Journal Entry
 Profit and Loss Appropriation A/c Dr. 25,000
 To Reserve Fund A/c 25,000
 Effect(1) P&L appropriation account, an non-current items
will decrease by Rs. 25,000
 Effect(2) Reserve Fund, another non-current item will
increase by Rs. 25,000
 Non Effect: This transaction does not affect the working
capital as it has no effect either on current assets or on
current liabilities.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
IV. Transaction involving both current
assets
 Transaction: Received cash from Debtors Rs. 50,000
 Journal Entry
 Cash ,A/c Dr. 50,000
 To Debtors 50,000
 Effect(1) Amount of cash , a current asset will increase by Rs. 50,000
(i.e. from Rs. 70,000 to Rs. 120,000)
 Effect(2) Amount of debtors or book – debts – another current asset
will decrease by Rs. 50,000 (i.e. from 125,000 to Rs. 75,000) But
the total value of current asset and current liabilities remain the
same at Rs. 300,00 and Rs. 100,000 respectively.
 Net Effect: There is no flow of funds as this transaction results in
neither increase nor decrease in the working capital.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


V. Transaction involving both current
liabilities
 Transaction: issued bills payable to creditors Rs. 25,000
 Journal entry
 Creditors A/c Dr. 25,000
 To Bills payable A/c 25,000
 Effects (1) Amount due to creditors, a current liability
will decrease by Rs.25,000 (i.e. from 75,000 to
Rs.50,000)
 Effects (2) Bills payable another current liability will
increase by Rs.25,000 (i.e. from Rs. 25,000 to Rs.
50,000) But the total amount of current liabilities and
current assets remain the same at Rs. 100,000 and Rs.
300,000 respectively.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
VI Transactions involving both Non-
current assets
 Transaction: Purchased Machinery for Rs. 50,000 in
exchange of land & buildings.
 Journal entry: Machinery A/c Dr Rs. 50,000
 To Land & Buildings 50,000
 Effects(1) Value of machinery, a non-current asset will
increase Rs. 50,000 i.e. from 75,000 to 125,000
 Effect(2) value of land & buildings, another non current asset
will decrease by Rs. 50,000 i.e. from 100,000 to Rs. 50,000
 Net effect: As this transaction has no influence either on
current assets or on current liabilities, the existing working
capital remains unaffected. As such, there is no flow of
funds.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Fund Flow Statement – Meaning
 Funds flow statement is the most useful statement
prepared to indicate the changes in the financial
condition of a business concern between the
opening and closing balance sheet dates. It is a
financial operational statement which reveals the
methods by which a company has been financed. In
other words, it is financial report on the movement
of funds (i.e. working capital) stating sources from
which the funds generate and to which these funds
are put into.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Fund Flow Statement – Defintion
 In the words of Faulke, it is a statement of sources
and application of funds is a technical device
designed to analyze the changes in the financial
condition of the business enterprise between two
dates.
 Almand Comemad observes, “ the funds statement is
a statement summarizing significant financial
changes which have occurred between the
beginning and the end of company’s accounting
period”

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Fund Flow Statement – Definition
 According to Robert Anthony, “the funds flow
statement describe the sources from which
additional funds were derived and the uses to which
these funds were put”
 According to smith & brown “ A fund flow statement
is prepared in summary form to indicate the
changes occurring in terms of financial condition
between two different balance sheet dates”

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Fund Flow Statement – Definition
 Thus, funds flow statement is a statement which states the sources
from which the funds were derived during a certain period and the
uses to which they have been put into during that period. A fund
flow statement is called by different names such as:
 Statement of sources and application of funds
 Statement of derivation and disposition of means of operation.
 Where got and where gone statement
 Funds movement statement
 Statement of sources and uses of funds
 Inflow and outflow statement
 Movement of working capital statement and
 Statement of receipts and disbursement of funds etc.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Significance or Utility of Funds flow
Statement
 There is a general recognition in the Industry and business
and among professional accounting bodies that financial
statements should provide relevant information which sub-
serves the multiple objectives of shareholders, investors,
creditors and the public and which enable them to arrive at
rational economic decision. Normally, what the shareholders
look for in these statements is an account of
stewardship(karwarIce kam ) of the firm and the amount which
may be expected as dividend. Potential investors look upon
funds flow statements as the source of realistic view of the
value of the company’s shares in terms of an expected
future stream of distribution, and judge the efficiency of the
management accordingly.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Significance or Utility of Funds flow
Statement
 A fund flow statement offers the following advantages
(i) It provides information about how funds are obtained
and how they are put to actual use.
(ii) It registers changes in the flow of funds during a
given period of time.
(iii) It is supplementary to conventional financial
statements.
(iv) It indicates how funds are generated from different
financial sources of a corporation and how the
reservoir(sa#v`) of its assets is created. In other
words, it depicts changes in the financial structur of
the corporation.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Significance or Utility of Funds flow
Statement
v. It is an important tool in the hands of financial
manager in the process of decision making.
vi. It determines the financial consequences of business
operations. It explains why, inspite of making profits,
a corporation is facing an illiquid position.
vii. It enables the financial manager to obtain answer to
a number of questions regarding the amount of loan
requirements, purposes for which it may be required,
the terms of repayment, the source of repayment etc.
viii. It may enable the financial manager to allocate
resources to productive investments.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Significance or Utility of Funds flow
Statement
ix. It evaluates the urgency of operational matters,
and makes its easier for the corporation to set a
time within which its operating problems may
come to critical stage. In other words, it may
enable it to find out when its resources are likely
to be exhausted.
x. It may enable the management to take decisions
on planning a dividend policy, on chalking out a
programme of financial re-organization etc.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Significance or Utility of Funds flow
Statement
xi. Taken in conjunction with the balance sheet and
the operating statement the funds flow analysis
provides a real source of information on possible
managerial issues.
xii. It is closely related to the normal business decision
making process, accounting statements, balance
sheets and income statements and is related to a
time span.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Limitation or Drawbacks of Funds flow
statement
 A funds flow statement offers many advantages but
it is not free from limitations. Its limitations are:
1. It is prepared taking into consideration only fund
items and non-fund items are ignored. As such, it is
incomplete and unscientific.
2. It is prepared on the basis of financial statements
viz. profit and loss account and balance sheet. The
information provided by these financial statements
is historical in nature. Therefore, it may not provide
accurate information about future.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Limitation or Drawbacks of Funds flow
statement
3) It is concerned with the systematic re-arrangement of
data furnished by financial statements. As such, it is
not original in nature.
4) It cannot reveal continuous changes.
5) 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.
6) It provides information about changes in the working
capital only and ignores information about changes in
cash, which are more relevant and important than
working capital.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Preparation of Funds flow Statement-
Procedure
 As already stated, funds flow statement is a technical deice
designed to indicate changes in financial position between
two period of time. Broadly speaking funds flow statement
consist of two parts (i) Schedule of changes in working
capital (2) Statement of sources and uses of funds. While
preparing the fund flow statement, one should follow the
steps stated below:
 Prepare a statement or schedule of changes in working
capital
 Prepare funds flow statement: Before preparing funds flow
statement, ascertain: various items of sources of funds and
various items of application of funds then prepare fund
flow statement.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Preparation of Schedule of changes in
Working capital
 The excess of current assets over current liabilities is called
working capital. Therefore working capital = Current Assets
– Current Liabilities. As such, the following steps should be
taken while preparing schedule of changes in the working
capital.
 Identify current assets and current liabilities in the given
balance sheets
 Compare the current assets and current liabilities of the
current year with that of the previous year and find out the
differences in each individual current asset and current
liability and consider such difference as increase or
decrease in working capital based on following points

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Preparation of Schedule of changes in
Working capital
 An increase in current assets increases working capital
 An increase in current liability decreases working
capital.
 A decrease in current assets decreases working capital
 A decease in current liability increases working capital.
 Consider the total difference between the total increase
or decrease in the working capital as the net increase
or decrease in working capital

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Alternatively
1. Find out separately, the total of current assets and
current liabilities of two periods.
2. Deduct total current liabilities from the total
current assets, difference being working capital
and
3. Compare the working capital of one period so
calculated with that of another period., the
difference being the net increase or decrease in
working capital.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Problem on Preparation of Schedule of
changes in working capital
 From the following balance sheet as on 31st March 2008 and 2009, you
are required to prepare a schedule of changes in working capital.
Balance Sheet
Liabilities 2008 2009 Assets 2008 2009
Equity Share capital 60,000 80,000 Land & Buildings 59,000 95,000
Share premium 10,000 11,000 Plant & Machinery 20,000 40,000
General Reserve 7,000 8,200 Furniture & fittings 3,000 1,500
P&L A/c 18,000 23,000 Stock 10,000 15000
6% Debentures - 30,000 Debtors 40,000 42,000
Corporate Taxes 10,000 14,000 Bank 6,000 8,700
Creditors 35,000 42,000 Cash 2,000 6,000
Total 140,000 208,200 140,000 208,200

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Schedule of changes in working capital
2008 2009 Changes in working capital
Increase Decrease
Current Assets
Stock 10,000 15,000 5,000 -
Debtors 40,000 42,000 2,000 -
Bank 6,000 8,700 2,700 -
Cash 2,000 6,000 4,000 -
Total 58,000 71,700 -
Current Liabilities
Corporate taxes 10,000 14,000 4,000
Creditors 35,000 42,000 7,000
Total 45,000 56,000
Net increase in Working capital 2,700
Total Prof. Prakash K Kankure, M Com, CWA(In) MBA
13,700 13,700
Alternatively
2008/Rs. 2009/Rs.
Current Assets
Stock 10,000 15,000
Debtors 40,000 42,000
Bank 6,000 8,700
Cash 2,000 6,000
Total 58,000 71,700
Less Current Liabilities
Corporate taxes 10,000 14,000
Creditors 35,000 42,000
Total 45,000 56,000
Difference Working capital 13,000 15,700
Net Increase in Working capital 2,700
Prof. Prakash K Kankure, M Com, CWA(In) MBA
15,700 15,700
Illustration
 Prasad Ltd. had the following Balance sheet on 31st March 2009
Liabilities Rupees Assets Rupees
Share Capital 1,00,000 Buildings 40,000
Creditors 40,000 Stock 20,000
Cash 80,000
 Total
Following is the summary of1,40,000
transactions for the year 2010 1,40,000
 Purchases Cash Rs. 15,000 Credit Rs. 35,000
 Cash paid to creditors Rs. 5,000
 Sales in Cash Rs. 20,000 Credit Sales Rs. 80,000
 Operating Expenses Cash paid Rs 20,000
 Closing stock Rs. 20,000, Show the net changes in working capital.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Solution
 In this problem, the information about the current
assets and liabilities such as debtors, cash and
creditors as on 31st March 2010 is not given. Hence
before preparing the statement changes in working
capital they have to be ascertained as follows.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


1. Creditors as on 31.3.2010
Particulars Rupees Particulars Rupees
To Cash 5,000 By Balance 40,000
b/d
To Closing 70,000 By Purchases 35,000
balance
75,000 75,000

Prof. Prakash K Kankure, M Com, CWA(In) MBA


2. Debtors as on 31.03.2010
Particulars Rupees Particulars Rupees
To Op Nil By Balance 80,000
balance B/d
To Sales 80,000
80,000 80,000

Prof. Prakash K Kankure, M Com, CWA(In) MBA


3. Cash balance as on 31.03.2010
Particulars Rupees Particulars Rupees
To Balance 80,000 By Purchases 15,000
To Sales 20,000 By Creditors 5,000
By Op. Exp 20,000
By Balance 60,000
1,00,000 1,00,000

Prof. Prakash K Kankure, M Com, CWA(In) MBA


4. Balance Sheet as on 31.03.2010
Liabilities Rupees Assets Rupees
Share Capital 100,000 Cash 60,000
P & L (Bal fig) 60,000 Debtors 80,000
Creditors 70,000 Stock 50,000
Building 40,000
230,000 230,000

Prof. Prakash K Kankure, M Com, CWA(In) MBA


5. Profit Rs. 60,000 as calculated
above is correct or not verification
 Trading & Profit and Loss A/c
Particulars Rupees Rupees Particulars Rupees Rupees
To Op Stock 20,000 By Sales
Cash 20,000
Credit 80,000 1,00,000
To Purchases
Cash 15,000 By Closing
Credit 35,000 50,000 Stock 50,000
To G P 80,000
Total 150,000 Total 150,000
To Op Exp. 20,000 By G P 80,000
To Net profit 60,000
Total 80,000 Total 80,000

Prof. Prakash K Kankure, M Com, CWA(In) MBA


6. Statement showing changes in
working capital
2009/Rs. 2010/Rs.
Current Assets
Stock 20,000 50,000
Debtors - 80,000
Cash 80,000 60,000
Total 100,000 190,000
Less Current Liabilities
Creditors 40,000 70,000
Total 40,000 70,000
Difference Working capital 60,000 120,000
Net Increase in Working capital 60,000
120,000 120,000

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Homework
 From the following Balance Sheet of Bharat Ltd for 2008 and 2009 you are required to
prepare schedule of changes on the working capital

Liabilities 2008 2009 Assets 2008 2009


Eq Sh Capital 200,000 300,000 Goodwill 50,000 40,000
10% Red P Shares 100,000 50,000 Building 100,000 75,000
Gen Reserve 20,000 55,000 Plant 90,000 191,000
Cap Reserve 18,000 27,000 Investments 10,000 35,000
Prop Dividend 28,000 39,000 Stock 85,000 78,000
Account Payable 25,000 47,000 Bills Receble 15,000 18,000
Bills payable 10,000 6,000 Debtors 60,000 90,000
Liab for expenses 8,000 6,000 Cash 7,000 6,000
Prov for taxation 28,000 32,000 Bank 10,000 22,000
Total 437,000 562,000 437,000 562,000
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Difference between Fund flow
statement and Income Statement
Points of Income Statement Funds Flow Statement
Difference
Contents - Contents only revenue items Contents both revenue and
capital items
Basis Income statement is not Is prepared using the information
prepared from information provided by the Position
provided by the funds flow statement
statement
Focus Disclose the results of business Discloses the manner in which the
operations funds were obtained and used in
the business.
Matching Matches the revenue of a Matches the source of funds with
period with the expenditure uses of fund.
incurred for that period.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Distinction between Position Statement
and Funds Flow statement
Points of Position Statement Funds Flow statement
difference
Purpose Is prepared to ascertain the Is prepared to indicate the
financial position of the business changes in the working capital
enterprise as on a particular between the two balance sheet
date dates
Contents Shows Assets and Liabilities of Shows sources and application
the business enterprise of funds
Nature It is static in nature It is dynamic in nature
Construction Is the end product of all Is a post balance sheet exercise
accounting operations of a
particular period.
Publication Is a must, because it is meant for Is not compulsory because it
outsider meant for internal use by the
management
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Preparation of Fund Flow Statement

 Generally, a funds flow statement is prepared in


two forms, such as:
 In the form of statement or report and or
 In the form of an Account or T form

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Specimen of Statement or Report form
of Funds flow statement
Sources of Funds Rs.
Sources or funds from operations
Issue of shares
Issue of debentures
Raising of long term loans
Sale of fixed or non-current assets
Sale of long-term or trade investments
Non-trading income – dividend received
Decrease in working capital (as per schedule of changes
in working capital)
Total Prof. Prakash K Kankure, M Com, CWA(In) MBA
Specimen of Statement or Report form
of Funds flow statement
Application of Funds Rs.
Sources or funds lost in operations

Redemption of preference shares

Redemption of debentures

Repayment of long term loans

Purchase of Fixed or non current assets

Purchase of long term investments

Payment of dividends in cash

Payment of tax in cash

Increase in working capital (as per schedule in changes of working capital)

Total Prof. Prakash K Kankure, M Com, CWA(In) MBA


Specimen of T or Account form of funds
flow statement
Sources Rs. Application Rs.
Sources or funds from operations Sources or funds lost in operations
Redemption of preference shares
Issue of shares Redemption of debentures
Issue of debentures Repayment of long term loans
Raising of long term loans Purchase of Fixed or non current
assets
Sale of fixed or non-current assets Purchase of long term investments
Sale of long-term or trade Payment of dividends in cash
investments
Non-trading income – dividend Payment of tax in cash
received
Decrease in working capital (as Increase in working capital (as per
per schedule of changes in working schedule in changes of working
capital) capital)
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Total Total
Fund Flow statement
 Before we prepare fund flow statement let us
discuss how to ascertain various items of sources and
uses of funds to be shown in fund flow statement

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Sources of flows
(i) Sources of Funds from Operations: Funds from
operations is the main source of funds. The net profit
as disclosed by Profit & Loss A/c may not always
be equal to the amount of actual sources of funds
because balance of net profit shown in the Income
statement is ascertained after deducting from
revenue (i.e. Sales) a number of expenses, some of
which are non-und or non-operating items which do
not result in the outflow or inflow of funds. Such non-
operating items are:

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Sources of Funds from Operations
(a) Non Operating Expenses:
(1) Depreciation and Depletion Charges
(2) Amortization of intangible or fictitious Assets
Viz.
- Goodwill/patents/trademarks;
- Preliminary expenses
- Discount on issue of shares or debentures
- Deferred expenses if any
(3) Loss on sale of fixed or non-current assets.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Sources of Funds from Operations
4) Appropriation of retained earnings viz.
- Transfer to General reserve or Reserve fund
- Transfer to sinking fund
- Transfer to Dividend equalization fund
- Other transfer; if any
4) Dividend paid
5) Interim dividend paid
6) Provision for taxation (treated as non current liability)
7) Proposed dividend (treated as non current liability)
Hence, these items required to be added back to the current years
income or net profit as shown in the income statement.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Sources of Funds
(b) Non Operating incomes: Similarly, there are certain non-operating
incomes which have been credited to profit and loss account or
income statement while arriving at net profit or net loss. As such,
items should be deducted from the current years profit while
calculating funds from operations. They are:
(1) Dividend received
(2) Retransfer of excess provisions
(3) Profit on sale of fixed/non current assets
(4) Appreciation in the value of fixed assets
(5) Profit on sale of long term investments etc.
Generally, funds from operation are calculated by preparing Adjusted
Profit and loss account as displayed in next slide.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Adjusted Profit and Loss A/c
Rs. Rs.
To Depreciation and Depletion By Balance of P&L B/d Last year
Charges
To Amortization of: By Dividend Received
(a) Intangible Assets By Transfer of excess provisions
- Goodwill By Profit on sale of fixed Assets
- Patent Rights By Profit on sale of Long-term
- Trade Marks investments
b) Fictitious Assets By Funds from Operations
- Preliminary Expenses (Balancing figure)
- Deferred Expenditure

To Appropriation of retained
earnings
- General Reserve
- Dividend Eq Fund
- Sinking fund etc
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Adjusted Profit and Loss A/c
Rs. Rs.
To Dividend Paid
To Provision for Taxation
To Interim Dividend
To Proposed Dividend
To Net profit c/d (i.e. current year)
To Funds Lost in operation
(Balancing figure)
Total Total
Note: Proposed Dividend and provision for taxation may or may not be current liability.
In case if they are treated current liabilities, they should be shown in schedule of
changes in working capital only.
However, if they are treated noncurrent liabilities, then they should be considered as
internal appropriation of profits made during the year and should be added back to
current years profit while calculating funds from operations. But tax paid during the
year should be considered as application of fund.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Issue of Shares
 If there is any increase in share capital (may be equity
or preference) it is due to the fresh issue of shares
during the current year. As a result, there is inflow of
funds. Hence, such an increase in the share capital
should be treated as source of funds.
 The fresh issue of shares may be made (a) at par (b) at
premium or (c) at discount.
 In all these cases there is source of funds. If there is any
call money received in respect of partly paid shares, it
results in the inflow of funds. Hence, it becomes a source
of funds.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Issue of Shares
 However, in case, if there is any cross transaction as
to issue of shares such as:
(a) Issue of shares against purchase of fixed assets or
non current assets, it does not result in the inflow of
funds. Hence, it may be ignored while preparing
the funds flow statement.
(b) If there is conversion of existing debentures into
shares or vice versa, it does not result in the flow
of funds. Hence, it may be ignored while
preparing funds flow statement.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Issue of debentures
 If there is any increase in the amount of debentures, it
may be due to the fresh issue of debentures during the
current year. Such an increase indicates inflow of funds
and therefore, becomes source of funds. Debentures
may be issued at par, at premium or at discount and
results in source of funds.
 If cross transaction like exchange of debentures for
fixed assets then same rule applies which applied in
case of shares i.e. in such exchange transactions there is
no flow of funds. Hence they are ignored while
preparing the Funds flow statement.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Raising Long term loans
 Long term loans if any, raised during the year
results in inflow of funds, and as such, it is a source
of funds. However, if loans are raised for acquisition
of fixed assets or for repayment of existing long
term loans they do not form the source or
application of funds Hence they may be ignored
while preparing the funds flow statement.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Sale of Fixed or Non Current assets
 Sale of fixed assets or immovable assets such as
Land and Buildings, Plant and Machinery, etc. is a
cross transaction resulting inflow of funds. Hence it is
source of fund. However exchange of one fixed
asset for another is non-cross transaction. As such, it
do not result inflow or outflow of funds.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Sale of Long-term or Trade Investments
& Non Trading Income.
 This is also a cross transaction resulting inflow of
funds. Hence it is a source of funds.

 Dividends received, refund of tax, or any other non


trading income received during the year results in
inflow of funds. Hence it is treated as source of
funds.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Uses of Application of Funds
 1. Sources or funds Lost in Operations: Sources or
funds lost in operations means the operational
outflow of funds. Hence it is treated as use or
application of funds. (Ref. Adjusted Profit & Loss
Account)

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Redemption of Preference Shares or
Debentures
 If there are any preference shares or debentures redeemed
during the year, it amounts to outflow of funds. Hence it is
treated as use or application of funds. The preference
shares or debentures may be redeemed at par, at premium
or at discount. The treatment is when it is redeemed at par
or premium or discount at nominal value or face value plus
premium or minus discount is considered as outflow of funds.
 However if the preference shares or debentures are
redeemed by the issue of equity shares or other preference
shares or debentures as the case may be, such redemption
does not result in the outflow of funds. Hence such items may
be ignored while preparing funds flow statement.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Repayment of Long term loans
 Repayment of Long-term loans is a cross transaction
resulting in the outflow of funds. Hence, it is treated
as application of fund. However, raising of a long
term loan to repay existing long-term loan of a
kind, does not result in outflow of funds.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Purchase of Fixed or non current
assets& Long term investments
 Purchase of fixed assets or investments (if any)
during the year results in out flow of funds. Hence it
is treated as use or application of fund. However,
the exchange of fixed assets for share or
debentures or exchange of one existing fixed asset
with new fixed asset if any does not result in the
outflow or inflow of funds.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Payment of Dividend and tax in cash

 Payment of dividend or tax in cash is a cross


transaction resulting in outflow of funds. Hence, it is
treated as use or application of funds.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


How to ascertain missing or hidden
information
 Before preparing funds flow statement, one has to ascertain the
information missing in a given problem.
 Purchase of fixed asset or non current assets i.e. outflow of funds
 Sale of fixed or non current assets i.e. inflow of funds.
 Profit or loss on sale of fixed assets and investments(if any) so as to
ascertain actual sources from operations.
 Issue of shares or debentures during the year – out flow of funds.
 Redemption of preference shares or debenture during the year out
flow of funds.
 Appropriation of retained earnings
 Raising or repayment of long term loans if any etc.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


How to ascertain missing or hidden
information
 In order to ascertain these items, non-current assets
and non-current liabilities given in the balance
sheets are required to be analyzed further. These
are generally calculated by means of preparing
concerned ledger accounts, say, to find out purchase
of machinery made during the year, we have to
prepare machinery account, taking into
consideration all the information pertaining to
machinery account.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Provision for Taxation- Treatment
 Provision for taxation may be treated as current
liability or non current liability
(a) When treated as current liability: It becomes a

preferential creditor, i.e. charge on profits and an


immediate obligation of the company to pay it
within a short span of time. Hence it is shown in
schedule of changes in working capital like other
current liabilities and there is no further treatment.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Provision for Taxation- Treatment
(b) When treated as a non current liability: Provision
for taxation, in this case is not shown in schedule of
changes in working capital, rather it is treated as
appropriation of profit. Hence, the amount of profit
appropriated towards provision for taxation is
ascertained by preparing provision for taxation
account and added back to the net profit of the
current year in adjusted profit and loss account.
However, tax paid during the year is treated as
application of funds.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Treatment of Dividends
 Interim Dividend: It is a dividend paid to the
shareholders of the company during an accounting
year in anticipation of profit i.e. before preparing
final accounts. In other words, it is the dividend
declared or paid in between two balance sheet
dates. This dividend is added back to current profit
while preparing adjusted profit and loss account to
ascertain funds from operations and is also shown
as an application of funds flow statement.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Treatment of Dividends
 Proposed dividend: In the real sense, mere declaration
of dividend proposed by the directors of the company
cannot be a liability of the company, though it is shown
on the liabilities side of the balance sheets. As such, it
indicates appropriation of profits till it is accepted by
shareholders in annual general body meeting. Once it is
accepted by shareholders it becomes the liability of the
company.
 Proposed dividend may be a current liability or a non
current liability. Therefore, treatment of proposed
dividend differs depending upon circumstances such as:

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Treatment of Dividends
(a) When it is a current liability: When it is considered
as a current liability, it is shown in the schedule of
changes in working capital and there is no more
treatment.
(b) When it is non current liability: it is treated as an
appropriation of profit and the proposed
dividend account is prepared to find out amount
of profit appropriated towards dividend and the
same is added back to the current years profit
while ascertaining the funds from operations.

Prof. Prakash K Kankure, M Com, CWA(In) MBA


Depreciation as source of Funds
 In general depreciation is not a source of funds since
neither the current assets nor current liabilities are
affected. On providing depreciation, only the fixed
assets and the current years profit are decreased by
the amount of depreciation.
 The depreciation is added back to the profits merely to
determine the actual working capital from operations
since the profits are ascertained after debiting the item
depreciation which does not affect the working capital.
If the depreciation were source of funds, all enterprise
having shortage of funds could have improved their
financial position by providing more and more
depreciation.
Prof. Prakash K Kankure, M Com, CWA(In) MBA
Depreciation as source of Funds
 However, the following points should be noted regarding
depreciation:
1. Depreciation can indirectly influence the flow of funds by affecting
the tax liability. For instance, more depreciation means less tax
liability or less outflow of funds to income tax authorities.
2. In case the fixed assets are hired by an enterprise and hire
charges (which undoubtedly include a depreciation charge) are
paid for their use, funds from operations are reduced to that
extent.
3. In case of manufacturing concern, when current assets include
closing inventories and the value of closing inventories includes the
depreciation on fixed assets as a element of cost, depreciation
acts a source of funds in such a case.

Prof. Prakash K Kankure, M Com, CWA(In) MBA

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