THEORETICAL FRAME WORK

Two basis financial statement of important to owner, management and

investors and balance sheet and profit and loss account. They provide useful
financial data regarding the operation of firms. Though these are very important
functions there are certain other relations between the balance sheet and the
commencement and at the end of the accounting period, which are not disclosed
by these two statements and at the end of the accounting period, which are not
disclosed by these two statements and at the end of the accounting period
accounting period, which are not disclosed by these two statements. Neither of
these reveals the nature of the transaction entered into for financing the business
operation during the accounting period. Balance sheet does not closing the
disclose the details of items such as acquisition of new assets, liquidation of
certain liabilities etc. it is essential to know the extent of funds made available
during the accounting period as is to know the existing assets and liabilities
along with profit or loss made by a business concern.

The limitation of financial statements forced the need for a separate

additional financial statement to highlight on the major financing and
investment activities of a firm during the accounting period. Such a statement is
called the “statement of changes in financial position”

It summarizes various forms which funds have been tapped and different
used to which they have been applied. The statement does not serve as
substitutes for the balance sheet or profit and loss account, but serve to provide
additional particular, which are not furnished by the traditional statement.

The basic financial statement i.e., the balance sheet and profit and loss
account or income statement of business, reveal the net effect of the various
transactions on the operation and financial position of the company. The balance
sheet gives a summary of the assets and liabilities of an undertaking a particular
point of time. It reveals the financial status of the company. The assets side of
the balance sheet shows the deployment resources if an under taking while the
liabilities side indicates its obligations i.e., the manner in which these resources
were obtained.

The profit & loss account reflects the result of the business operations for
a period of time. It contains as summary of expenses incurred and the revenue
realized in an accounting period. Both these statements provide the essential
basic information on the financial activities of a business, but their usefulness is
limited for analysis &planning process. The balance sheet gives a view of the
resources (liabilities) of the business and the uses (assets) to which the resources
have been put at a certain point of time. It does not disclose the causes for
changes in the assets & liabilities between two different points of time .the
profit &loss account, in a general way, indicates the resources provided by the
operations. But there are many transactions that take place in an undertaking
and which do not operate through profit &loss account.

Thus another statement has to be showing the change in the assets and
liabilities from the end of one period of the time to the end of another period of
time. The statement is called a statement of changes in financial positions or a
funds flow statement.

The funds flow statement is a statement, which shows the movement of

funds is report of E-financial operations of the business undertaking. It indicates
various means by which funds were obtained during a particular period and the
ways in which these funds were employed. In simple words, it is a statement of
sources and application of funds.

DEFINITION

According to the R.A.FOULKE, “funds flow statement of sources and

application of the device design to analysis the changes in the financial
condition or business enterprises between two dates”.

According to the SMITH AND BROWN, “Funds Flow Statement is

prepared to indicate in summary form, changes occurring in items of financial
position between two different balance sheet dates".

According to the R.N. ANTHONY, “Funds Flow Statement is prepared

to indicate the increase in cash resources and the utilization of such resources of
a business during the accounting period”.

MEANING AND CONCEPTS OF FUNDS

The term “flow of funds” means “changes in funds” or “change in
working capital”. In other words, any increase or decrease in working capital
means “flow of funds”.

The following are the general rules;

1. There will be flow of funds if a transaction involves

  Current assets and fixed assets E.g. purchase of building for cash
 Current and capital. E.g. issues of share.
 Current and fixed liabilities E.g. redemption of debentures for cash
 Current liabilities and fixed liabilities E.g. creditors paid off
debentures
 Current liabilities and capital E.g. creditors paid off share.
 Current liabilities and fixed assets E.g. building transfer of
creditors in satisfaction of their claims

2. There will no flow of funds if a transaction involves

 Current assets and current liabilities E.g. payment made to
creditors
 Fixed assets and fixed liabilities E.g. building purchased and
payment made in debentures
 Fixed assets and capital E.g. building purchased and payment made
in shares.

These statement are classified into four categories

1. Income statement
2. Statement of changes in finance
3. Funds flow statements
4. Cash flow statement

INCOME STATEMENT

The Income statement is one of the three primary financial statements

used to assess a company’s performance and financial position (the two others
being the balance sheet and the Cash flow statement). The income statement
summarizes the revenue and expenses generated by the company over the entire
reporting period.

The income statement is also known as a profit and loss (P&L) statement,
statement of earnings, statement of operations or statement of income

The basic formula on which an income statement is based is:

Revenues – Expenses = Net Income

STATEMENT OF CHANGES IN FINANCE

In business accounting, the statement of change in financial position is

a financial statement that outlines the sources and uses of funds and explains
any changes in cash or working capital.
 It contains activities from operations that alter the cash of a company has
on hand. Changes in financial position include cash outflows, such as capital
expenditures, and cash inflows, such as revenue. It may also include certain
non-cash changes, such as depreciation.
The use of this statement is to provide relevant and focused on a period,
so that users of financial statements with sufficient information to:
 Evaluate the company’s ability to generate resources.
 Assess the reasons for the differences between net income and funds
generated or used by the operation.
 To assess the ability of the company to meet its obligations to pay
dividends, and if necessary, to anticipate the need for funding.
 To assess the changes in the company’s financial situation arising from
investing and financing transactions that occurred during the period.

CASH FLOW STATEMENT

In financial accounting, a cash flow statement, also known as statement
of cash flows, is a financial statement that shows how changes in balance sheet
account and income affect cash and cash equivalents, and breaks the analysis
down to operating, investing, and financing activities. Essentially, the cash flow
statement is concerned with the flow of cash in and out of the business. As an
analytical tool, the statement of cash flows is useful in determining the short-
term viability of a company, particularly its ability to pay bills. International
Accounting Standard 7 (IAS 7),
Under IAS 7, operating cash flows include:
 Receipts from the sale of goods or services.
 Receipts for the sale of loans, debtor equity instruments in a trading
Portfolio.
 Interest received on loans.
 Dividends received on equity securities.
 Payments to suppliers for goods and services.
 Payments to employees or on behalf of employees.
 Interest payments (alternatively, this can be reported under financing
activities in IAS7, and USGAAP)
People and groups interested in cash flow statements include:
 Accounting personnel, who need to know whether the organization will
be able to cover payroll and other immediate expenses?
 Potential lenders or creditors, who want a clear picture of a company's
ability to repay,
  Potential investor, who need to judge whether the company is financially
sound.
 Potential employees or contractors, who need to know whether the
company will be able to afford compensation.
 Company directors, who are responsible for governance of the company,
and are responsible for ensuring that the company doesn't trade while
insolvent,
 Shareholders of the business.

Cash flow from operating activities generally calculated according to the

following formula:

Cash Flows from Operations = Net income + Noncash Expenses + Changes

in working capital

CASH FLOW ACTIVITIES:

The cash flow statement is partitioned into three segments, namely:

1. Cash flow resulting from operating activities;
2. Cash flow resulting from investing activities; and
3. Cash flow resulting from financing activities.

The money coming into the business is called cash inflow, and money
going out from the business is called cash outflow.

FUND

The term ‘funds’ has been defined in a number of ways

In a narrow sense, it means cash only and a funds flow statement

prepared on this basis is called a cash flow statement. Such a statement
enumerates net effects of the various business transactions on cash and takes
into account receipts and disbursements of cash.

In a broader sense, the term ‘funds’ refers to money values in whatever

form it may exist. Here ‘funds’ means all financial resources, used in business
whether in the form of men, material, money, machinery and others.

In a popular sense, the term ‘funds’, means working capital, i.e., the
excess of current over current liabilities. The working capital concept of funds
has emerged due to the fact that total resources of a business are invested partly
in fixed assets in the form of fixed capital and partly kept in form of liquid or
near liquid form as working capital.

The narrower concept of ‘funds’, i.e. , cash or working capital concept,

fails to reveal the changes in the total financial resources of a business. Some
significant items, such as purchase of building in exchange of shares or payment
of bonus in the form of shares, which do not directly affect cash or working
capital are not revealed from the analysis based on these concepts.

However, the concept of funds as working capital is the most popular one
and in this chapter we shall generally refer to ‘funds’ as working capital and a
funds flow statement as a statement of sources and application of funds.

MEANING AND CONCEPT OF FLOW OF FUNDS

The term ‘flow’ means movement and includes both ‘inflow’ and
‘outflow’.

The term ‘flow of funds’ means transfer of economic values from one
asset of equity to another. Flow of funds is said to have taken place when any
transaction makes changes in the amount of funds available before happening of
the transaction.

If the effect of transaction results in the increase of funds, it is called a

source of funds and if it results in the decrease of funds, it is known as an
application of funds. Further, in case the transaction does not change funds, it is
said to have not resulted in the flow of funds.

According to the working capital concept of funds, the term ‘flow of

funds’ refers to the movement of funds in the working capital. If any transaction
results in the increase in working capital, it is said to be a 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.

RULE

The flow of funds occur when a transaction changes on the one hand a
non-current account and on the other a current account and vice-versa.
When a change in a non-current account e.g., fixed assets, long-term liabilities,
reserves and surplus, fictitious assets, etc., is followed by a change in another
non-current account, it does not amount to flow of funds. This is because of the
fact that in such cases neither the working capital increases nor decreases.
 Similarly, when a change in one current account results in a change in
another current account, it does not affect funds. Funds move from non-current
to current transactions or vice-versa only.

In simple language funds move when a transaction affects:

 A current asset and a fixed asset, or
 A fixed and a current liability, or
 A current asset and a fixed liability, or
 A fixed liability and current liability; and funds do not move when the
transaction affects fixed assets and fixed liability or current assets and
current liabilities.

CURRENT AND NON CURRENT ACCOUNTS

To understanding the flow of funds, it is essential to classify various

account & balance sheet items into current and non-current categories.

Current accounts can either be current assets or current liabilities. Current

assets that in the ordinary course as business can be or will be converted into
cash within a short period of one accounting year. Current liabilities are those
liabilities, which are intended to be paid in the ordinary course as business
within a short period of one accounting year.

CURRENT ASSETS

Current assets represent all the assets of a company that are expected to
be conveniently sold, consumed, utilized or exhausted through the standard
business operations, which can lead to their conversion to a cash value over the
next one year period. Since current assets is a standard item appearing in the
balance sheet, the time horizon represents one year from the date shown in the
heading of the company's balance sheet.

The broad categories of current assets are

1. Cash including fixed deposits with banks.

2. Accounting receivable, trade debts and bills receivable.
3. Inventory stock of raw material, work-in-progress, finished goods, stores
and spare parts.
 4. Advances recoverable the advance given to suppliers of goods and
services or deposit with government or other public authorities, custom
part of authorities, advance income tax.
5. Pre-paid expenses, cost of unexplored services, insurance premium paid
in advance.

CURRENT LIABILITIES

Current liabilities are financial obligations of a business entity that are

due and payable within a year. A liability occurs when a company has
undergone a transaction that has generated an expectation for a future outflow
of cash or other economic resources. The key operator in this definition is the
word “expectation,” as a liability does not necessarily always have to end up
resulting in an outflow of value, but must be reasonably expected to on
recognition of the liability.

While a current liability is defined as a payable due within a year’s time,

a broader definition of the term may include liabilities that are payable within
one business cycle of the operating company. In other words, if a company
operates a business cycle that extends beyond a year’s time, a current liability
for said company is defined as any liability due within the longer of the two
periods.

The broad categories of current assets are

1. Accounts payable, bills payable and trade creditors.

2. Outstanding expenses, expenses for which services have been received by
the payment have not been made.
3. Bank overdraft
4. Short-term loans, loans from banks which are payable within one year
from data of balance sheet.
5. Advance payment received by the business for the services to be rendered
or goods to be supplies in future.
6. Current majorities of long-term loans, long-term debts due within year of
those loans. Provided payable out of existing current assets or by
creations of current liabilities as discussed earlier. However, installment
of long-term loans due after a year should be taken as non-current
liabilities

NON-CURRENT ASSETS
 A non-current asset is an asset that is not expected to be consumed
within one year. If a company has a high proportion of noncurrent to current
assets, this can be an indicator of poor liquidity, since a large amount of cash
may be needed to support ongoing investments in non-cash assets.

Some noncurrent assets, such as land, may theoretically have

unlimited useful lives. A noncurrent asset is recorded as an asset when
incurred, rather than being charged to expense at once. Depreciation,
depletion, or amortization may be used to gradually reduce the amount of a
non-current asset on the balance sheet.

NON -CURRENT LIABILITIES

Noncurrent liabilities are those obligations not due for settlement

within one year. These liabilities are separately classified in an entity's
balance sheet, away from current liabilities.

Examples of noncurrent liabilities are:

 Long-term portion of debt payable

 Long-term portion of bonds payable

The aggregate amount of noncurrent liabilities is routinely compared to

the cash flows of a business, to see if it has the financial resources to fulfill
its obligations over the long term. If not, creditors will be less likely to do
business with the organization, and investors will not be inclined to invest in
it. A factor to be considered in this evaluation is the stability of an
organization's cash flows, since stable flows can support a higher debt load
with a reduced risk of default.

The following are the list of current assets and current liabilities;

Current liabilities Current assets

Bills payable Cash in hand
Sundry creditors Cash at bank
Outstanding expenses Bills receivable
Bank overdraft Sundry debtors
Short term loan and deposits Short term loans
Dividend payable Marketable investment
Provision for tax Closing stock
Provision against current assets Prepaid expense
Provision for dividend Accrued income

The following are the list of non-current assets and non-current liabilities;

Non-current liabilities Non-current assets

Equity share capital Good will
Preference share capital Land
Redeemable preference share Building
Capital
Debentures Plant and Machinery
Long term loan Furniture and Fittings
Share premium account Trade Marks
Provision for depreciation Discount on issue of
Against fixed assets Debentures
Capital reserve Discount on issue of shares
Profit and loss account (balance of Debit balance of profit and
profit i.e., credit Balance) loss account
Share forfeited account Long term investment
Capital redemption reserve Patent Rights

It throws light on many perplexing questions of general interest;

Which otherwise may be difficult to be answered, such as

1. Why were the net current assets of the firm down, though the net income
was up or vice versa?
2. How was it possible to distribute dividends in absence of or in excess of
current income for the period?
3. How was the sale proceeds of plant and machinery used?
4. How was the sale proceeds of plant and machinery used?
5. How were the debts retired?
6. What became to the proceed0s of share issue or debenture issue?
7. How was the increase in working capital financed?
 8. Where did the profits go?

FUNDS FLOW ANALYSIS

The funds flow analysis is a statement which shows the movement of

funds and is a report of the financial operations of the business undertakings. It
indicates various means by which funds were obtained during a particular
period and the way to which these were employed. In simple words it is a
statement of sources and application of funds.

The funds flow statement is a report on financial operations changes,

flows or movement during the period. It is a statement which shows the sources
and application of funds or it shows how the activities of a business are financed
in a particular period. In other words, such as statement shows how the financial
resources have been used during a particular period of time. It is, thus, designed
especially to analyze the changes in the financial conditions of enterprise.

Funds flow statement is not an income statement. Income statement

shows items of income and expenditure of a particular period, but the funds
flow statement is an operation statement as it summaries the financial activities
for a period of time it covers all movement that involve on actual assets, The
utility of this statement can be measured on the basis of its contribution to
financial management. It generally serves the following purposes:-

1. IT HELPS IN ANALYSIS OF FINANCIAL POSITION:

The basic purpose of preparing the statement is to have a rich into
the financial operations of the concern. It analyses how the funds were
obtained and used in the past. In this sense, it is a valuable tool for the
finance manager for analyzing the past and future plans of the firm and
their impact on the liquidity. He can deduce the reasons for the
imbalances in uses of funds in the past a take necessary corrective
actions.

2. EVALUATION OF THE FIRM'S FINANCING:

One important use of the statement is that it evaluates the firm'

financing capacity. The analysis of sources of funds reveals how the
firm's financed its development projects in the past i.e., from internal
sources or from external sources. It also reveals the rate of growth of the
firm.
3. AN INSTRUMENT FOR ALLOCATION OF RESOURCES:

In modern large scale business, available funds are always short for
expansion programmes and there is always a problem of allocation of
resources. It is, therefore, a need of evolving an order of priorities for
putting through their expansion programmes which are phased
accordingly, and funds have to be arranged as different phases of
programmes get into their stride. The amount of funds to be available for
these projects shall be estimated by the finance with the help of Funds
Flow Statement. This prevents the business from becoming a helpless
victim of unplanned action.

4. A TOOL OF COMMUNICATION TO OUTSIDE WORLD:

Funds Flow Statement helps in gathering the financial states of

Business. It gives an insight into the evolution of the present financial
position and gives answer to the problem 'where have our resources been
moving'? In the present world of credit financing, it provides a useful
information to bankers, creditors, financial, it provides a useful
information and government etc. regarding amount of loan required, its
proposes, the terms of repayment an sources for repayment of loan etc.
the financial manager gains a confidence born out of a study of Funds
Flow Statement. In fact, it carries information regarding firm's financial
policies to the outside world.

5. ITS ACTS AS FUTURE GUIDE:

An analysis of Funds Flow Statements of several years reveals

certain valuable information for the financial manager for planning the
future financial requirements of the firm and their nature too i.e. Short
term, long-term or mid-term. The management can formulate its financial
policies based on information gathered from the analysis of such
statements. Financial manager can rearrange the firm's financing more
effectively on the basis of such information along with the expected
changes in trade p payables and the various accruals. In this way, it
guides the management in arranging its financing more effectively.

6. IT HELPS IN APPRAISING THE USE OF WORKING CAPITAL:

 A funds flow statement helps in explaining how efficiently the
management has used its working capital and also suggests way to
improve working capital position of them firm.

7. IT HELPS KNOWING THE OVERALL CREDIT WORTHINESS

OF A FIRM:

The financial institutions and banks such as state financial

institutions, industrial development corporation, industrial finance
corporation of India, industrial development bank of India etc., all ask for
funds flow statement constructed for a number of years before granting
loans to know the credit worthiness and paying capacity of the firm.
Hence, a firm seeking financial assistance from these institutions has no
alternative but to prepare funds flow statement.
PRINCIPAL SOURCES OF FUNDS

 Issue of share and debentures.

 Long term and medium term borrowings.
 Sale of fixed assets and long-term investment.
 Funds for operations or trading income.
 Non-trading income such as income from investment, damage awarded in
legal action.

POSSIBLE USE OF FUNDS

Though there are not numerous applications of funds, the main categories
as follows:
 Redemption of shares & debentures.
 Repayment of long and medium term loans.
 Purchase of fixed assets and long term investments.
 Funds lost in operations i.e. trading losses.
 Non-trading losses such as loss of cash embezzlement, fines etc.

DIFFERENCE BETWEEN FUNDS FLOW STATEMENT AND BALANCE

SHEET:

FUNDS FLOW STATEMENT BALANCE SHEET

A. It is a statement of changes in A. It is a statement of financial is
Financial position and hence position on a particular date and
is Dynamic in nature hence static in nature.
 B. It shows the sources and
Applications of funds in a
Particular period of time.
C. It is a tool of management for
financial analysis and helps in
making decisions.
D. Usually, schedule of changes in
Working capital has to be
prepared before preparing funds
flow Statement.
DIFFERENCE BETWEEN FUNDS FLOW & CAH FLOW STATEMENT
FUNDS FLOW STATEMENT
A. It is based on a wider concept of
Funds, i.e., working capital.
B. It is based on accrual basis of
accounting.
C. Schedule of changes in working
capital is required to be
prepared.
D. Funds Flow Analysis reveals the
sources and applications of
funds the net difference between
sources and application of funds
represents net increase or
decrease in working capital.
E. It is useful for long term
planning.
DIFFERENCE BETWEEN FUNDS FLOW & INCOME STATEMENT
FUNDS FLOW STATEMENT
1) Funds Flow Statement
presents various ways from
which funds have been
procured and the applications
for the same.
B. It depicts the assets and funds
liabilities at a Particular point of
time.
C. It is not of much help to
management in making
decisions.
D. No such schedule of changes in
working capital is required
CASH FLOW STATEMENT
A. It is based on a narrower
concept of funds i.e., Cash.
B. It is based on cash basis of
Accounting.
C. Schedule of changes in
working capital is not
required to be prepared.
D. It is prepared by taking the
opening balance of cash,
adding to this all the inflows
of cash and deducting the
outflows of cash from the
total, difference represents
Closing balance of cash.
E. It is more useful for short
term analysis and cash
INCOME STATEMENT
1) Income Statement presents only
the financial results of a firm,
i.e. profit or loss of a firm.
 2) Income Statement, two
periodical Balance Sheets
supply the necessary
information.
3) Funds Flow Statement
incorporates both capital and
revenue transactions. It
maintains records from all
sources of funds, irrespective
of capital and revenue.
4) It is complementary to
Income Statement. It takes
help from Income Statement.
5) There is no specific format
for preparing a Funds Flow
Statement.
6) Funds Flow Statement
reveals the changes in final
position and prescribes the
various ways from which
funds were collected and
applied.
7) Since a Funds Flow
Statement is prepared on the
basis of current prices, the
statement is not affected by
inflation.
8) . It helps the management to
take decisions relating to
finance.
9) It is not mandatory.
2) Nominal accounts’ balances are
taken for it preparation.
3) Income Statement records only
revenue items, i.e. operating
expenses and operating
incomes, which are required for
ascertaining profit or loss.
4) Income Statement does not
depend on Funds Flow
Statement.
5) Income Statement is prepared
on the basis of prescribed
format.
6) It does not reveal the changes in
financial positions but presents
only the result of the operation
in the form of profit or loss.
7) Income Statement is presented
on the basis of historical prices.
8) It cannot help in such decisions.
9) It is mandatory.

FUNDS FLOW STATEMENT, INCOME STATEMENT AND BALANCE

SHEET:
Funds flow statement is not a substitute of an income statement i.e., a
profit and loss account and a balance sheet. The profit and loss account id
document, which indicates that the extent of success achieved by a business in
earning profits. It reports the results of business activity and loss account does
not highlight the change in the financial position of a business. It does not
reveal the inflows and outflows of funds in business during a particular
business.
A balance sheet is a statement of financial position or status of business
on a given data. It is prepared at the end of accounting period. The balance sheet
deficits various resources of an undertaking and the deployment of these
resources in various assets on a particular date. It is static in nature, while funds
flow statement is a dynamic one.

Funds statement tells many financial facts, which a balance sheet cannot
tell, balance sheet does not disclose the cause for changes in the assets and
liabilities between two different points of the time again, while balance sheet is
the end of result of all accounting operations for a period of time, funds
statement is essentially a post balance sheet exercise. It is prepared (funds flow
statement) to show various sources from which the funds came into business
and various application where they have been used.

Hence, funds flow statement is not competitive but complimentary to

financial statements. The funds statement provides additional information to
regards changes in working capital, derived from financial statement at two
points of time. It is a tool of management for financial analysis and helps in
making a decisions.

OBJECTIVES OF FUNDS FLOW STATEMENT:

The utility of this statement can be measured on the basis of its

contribution to the financial management. It generally serves the following
purposes:

1. IT HELPS IN ANALYSIS OF FINANCIAL POSITION:

The basic purpose of preparing the statement is to have a rich into
the financial operations of the concern. It analyses how the funds were
obtained and used in the past. In this sense, it is a valuable tool for the
finance manager for analyzing the past and future plans of the firm and
their impact on the liquidity. He can deduce the reasons for the
imbalances in uses of funds in the past a take necessary corrective
actions.

2. EVALUATION OF THE FIRM'S FINANCING:

One important use of the statement is that it evaluates the firm'

financing capacity. The analysis of sources of funds reveals how the
firm's financed its development projects in the past i.e., from internal
sources or from external sources. It also reveals the rate of growth of the
firm.
 3. AN INSTRUMENT FOR ALLOCATION OF RESOURCES:

In modern large scale business, available funds are always short for
expansion programmes and there is always a problem of allocation of
resources. It is, therefore, a need of evolving an order of priorities for
putting through their expansion programmes which are phased
accordingly, and funds have to be arranged as different phases of
programmes get into their stride. The amount of funds to be available for
these projects shall be estimated by the finance with the help of Funds
Flow Statement. This prevents the business from becoming a helpless
victim of unplanned action.

4. A TOOL OF COMMUNICATION TO OUTSIDE WORLD:

Funds Flow Statement helps in gathering the financial states of

Business. It gives an insight into the evolution of the present financial
position and gives answer to the problem 'where have our resources been
moving'? In the present world of credit financing, it provides a useful
information to bankers, creditors, financial, it provides a useful
information and government etc. regarding amount of loan required, its
proposes, the terms of repayment an sources for repayment of loan etc.
the financial manager gains a confidence born out of a study of Funds
Flow Statement. In fact, it carries information regarding firm's financial
policies to the outside world.

5. ITS ACTS AS FUTURE GUIDE:

An analysis of Funds Flow Statements of several years reveals

certain valuable information for the financial manager for planning the
future financial requirements of the firm and their nature too i.e. Short
term, long-term or mid-term. The management can formulate its financial
policies based on information gathered from the analysis of such
statements. Financial manager can rearrange the firm's financing more
effectively on the basis of such information along with the expected
changes in trade p payables and the various accruals. In this way, it
guides the management in arranging its financing more effectively.

IMPORTANCE OF FUND FLOW STATEMENT:

The importance of fund flow statement may be summarized:

1. ANALYSES FINANCIAL STATEMENTS:
Balance Sheet and Profit and Loss Account do not reveal the
changes in the financial position of an enterprise. Fund flow analysis
shows the changes in the financial position between two balance sheet
dates. It provides details of inflow and outflow of funds i.e., sources and
application of funds during a particular period.
Hence it is a significant tool in the hands of the management for
analyzing the past, and for planning the future. They can infer the reasons
for imbalances in the uses of funds in the past and take corrective
measures for the future.

2. ANSWERS VARIOUS FINANCIAL QUESTIONS:

Fund flow statement helps us to answers various financial
questions such as:
a) How much fund flowed into the business?

b) How much of these funds were provided by the operations?

c) What are the other sources of funds?

d) How were these funds used?

e) Why was there less/more amount of net working capital at the end
of the period than at the beginning?

f) Why were the dividends not larger?

g) How was the purchase of fixed assets financed?

h) How were the loans repaid?

3. RATIONAL DIVIDEND POLICY:

Sometimes it may happen that a firm, instead of having sufficient

profit, cannot pay dividend due to inadequate working capital. In such
circumstances, fund flow statement shows the working capital position of
a firm and helps the management to take policy decisions on dividend etc.
 4. PROPER ALLOCATION OF RESOURCES:
Financial resources are always limited. So it is the duty of the
management to make its proper use. A projected fund flow statement
enables the management to take proper decision regarding allocation of
limited financial resources among different projects on priority basis.

5. GUIDE TO FUTURE COURSE OF ACTION:

The future needs of the fund for various purposes can be known
well in advance from the projected fund flow statement. Accordingly,
timely action may be taken to explore various avenues of fund.

6. PROPER MANAGING OF WORKING CAPITAL:

It helps the management to know whether working capital has been

effectively used to the maximum extent in business operations or not. It
depicts the surplus or deficit in working capital than required. This helps
the management to use the surplus working capital profitably or to locate
the resources of additional working capital in case of scarcity.

7. GUIDE TO INVESTORS:

It helps the investors to know whether the funds have been used
properly by the company. The lenders can make an idea regarding the
creditworthiness of the company and decide whether to lend money to the
company or not.

8. EVALUATION OF PERFORMANCE:

Fund flow statement helps the management in judging the financial

and operating performance of the company.

ADVANTAGES OF FUNDS FLOW STATEMENT:

1. Helps in the evaluation of alternative finance and investments plan.

2. Managements of various companies are able to review their budget with
the aid of fund flow statement.
 3. Investors are able to measure as to how the company has utilized the
funds supplied by them and its financial strengths with the aid of funds
statement.
4. Helps in the planning process of a company.
5. It is an effective tool in the allocation of resources.
6. It explains the relationship between the changes in the working capital
and net profits.

DISADVANTAGES OF FUNDS FLOW STATEMENT:

1. It should remember that a Fund Flow Statement is not a substitute of an

income statement or a balance sheet.
2. It provides only some additional information as regards in working
capital. As such it must be remembered that funds flow statement is not a
substitute of the income statement.
3. It cannot reveal continuous changes.
4. 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.
5. It is prepared taking into consideration only funds items and non funds
items are ignored. As such, it is complete and unscientific.

USE OF FUNDS FLOW STATEMENT:

1. It helps the financial analyst in having a more detailed analysis and

understanding of changes in the distribution of resources between two
balance sheets.
2. It explains the financial consequences of business operation.
3. It acts as an instrument for allocation of resources.
4. The funds should be managed in such a way that the position to make
payment of interest and loan installments as per the agreed schedule.
5. It is a test as to effective or otherwise use of working capital by the
management during a particular period.

LIMITATIONS OF FUND FLOW STATEMENT:

Despite its various advantages, the fund flow statement suffers from
certain limitations:
1. HISTORICAL NATURE:
 The information used for the preparation of the fund flow
statement is essentially historical in nature. It does not estimate the
sources and application of funds for the near future.

2. STRUCTURAL CHANGES NOT DISCLOSED:

The fund flow statement does not disclose the structural changes in
financial relationship in a firm. In other words, it does not reveal shifts
among items making up the current assets and current liabilities. It does
not tell us whether any loss of working capital has unduly weakened the
financial position or not.

3. NOT FOOL PROOF:

The fund flow statement is prepared from the data provided in the
balance sheet and profit and loss account. Hence, the defects in financial
statements will be carried over to the fund flow statement also.

4. IGNORES NON-FUND ITEMS:

As fund flow statement ignores non-fund items, it becomes a crude
device compared to income statement and balance sheet.

5. NOT RELEVANT:

A study of changes in cash (i.e., cash flow statement) is more

relevant than a study of changes in funds for the purpose of managerial
decision-making.

CONSTRUCTION OF THE FUNDS FLOW STATEMENT

The comparative balance sheet at the beginning and end of the account
period serve as basic document for the constructions of the funds flow
statement. The normal operations of business are reflected in the balance sheet
by way of increase or decrease in the various assets and liabilities and in the
properties funds as represented by equity capital and reserves.

FORMAT – HORIZONTAL
 FUNDS FLOW STATEMENT
(STATEMENT OF SOURCES AND APPLICATION OF FUNDS)

SOURCES AMOUNT APPLICATION AMOUNT

Issue of Equity Shares Purchase of Fixed

Assets
Issue of Preference shares Purchase of
Investments
Issue of Debentures Redemption of shares

Loan borrowed Redemption of

debenture
Sale of Fixed Assets Payment of loan

Non-trading incomes Payment of tax

Fund from Operation Payment of Dividend

(profit)
Decrease of working Non-trading losses
capital
Increase of working
capital
Fund from operation
(loss)
Total Total

FORMAT – VERTICAL
FUNDS FLOW STATEMENT
(STATEMENT OF SOURCES AND APPLICATION OF FUNDS)

PARTICULAR AMOUNT AMOUNT

Sources of Funds:
Issue of Equity Shares
Issue of Preference shares
Issue of Debentures
Loan borrowed
Sale of Fixed Assets
Sale of Investments
Non-trading incomes
Fund from Operation (profit)
Decrease of working capital
Total Sources of Funds (A)
Application of Funds:
Purchase of Fixed Assets
Purchase of Investments
Redemption of shares
Redemption of debenture
Payment of loan
Payment of Tax
Payment of Dividend
Non-trading losses
Increase of working capital
Fund from operation (loss)
Total Application of Funds (B)

PRO-FORMA – WORKING CAPITAL STATEMENT

PARTICULARS PREVIOUS CURRENT EFFECT ON WORKING

YEAR YEAR CAPITAL
INCREASE DECREASE
Current Assets:
Cash on Hand
Sundry Debtors
Bills Receivable
Stock/ Inventory
Prepaid Expenses
Short-term Investments
Outstanding Incomes
Total Current Assets
(A)
Current liabilities:
Sundry Creditors
Bills Payable
 Bank Overdraft
Outstanding Expenses
Short-term Loan
Prepaid Incomes
Provision of Taxation
Total Current Liabilities
(B)
Net Working Capital (A
- B)
Net Increase / Decrease
in Working Capital
Total

FORMAT OF ADJUSTING PROFIT OR LOSS ACCOUNT

Particular Amount Particular Amount

To Non-Fund items (non- By Balance b/d (opening
cash) balance)
To Depreciation / Depletion By Non-Fund items
(non-cash)
To Loss on sale of fixed By Dividend received
assets
To Premium on redemption By Interest received
debentures and preference
shares
To Discount on issue of By Refund on taxes
shares and debentures
To Write off intangible By Profit on sale of fixed
assets (goodwill patent, assets
trade-mark)
To Write off fictitious assets By Change in stock
(preliminaryexp.,advertisem (current assets)
ent,)
To Appropriation / By Adjusted Profit
Provision General reserve (funds from operations)
To Proposed dividend
(equity and Preference
shares)
To Taxation provision
To Interim dividend
To balance C/D (Closing
Balance)
To Debenture sinking fund
Total Total