Funds Flow Statement: Definition, Objectives, Importance, Limitation

What is Funds Flow Statement?

Fund flow statement is a statement which explains the change in the items of balance sheet over the period of time. A fund flow statement examines the sources and uses of funds of a firm between two points of time.

The term “Funds” has been described in many ways. Many interpret funds as cash only and fund flow statement prepared of this ratio is called a cash flow statement.

In this type of statement only inflow and outflow of cash flow obtain into account. This narrow concept of cash flow often leads to omission of such items which do not directly affect cash or working capital.

Thus the term funds flow refers to change in working capitals. The sources and the composition of working capital at the end of the period are important factors in evaluating post activities and in judging a company’s ability to prosper in the future.

Fund Flow Statement discloses the result or the policies followed by the financial management in a way which makes it more understandable to observe than the other financial statement.

Meaning of Fund

Meaning of Funds: In a limited sense, the term ‘fund’ means ‘cash’. But this is not the correct meaning of the term ‘fund’ because there are many transactions in the business which do not result in inflow or outflow of cash but certainly result in the inflow or outflow of funds.

For example, a machine is purchased on two months credit. Although cash is not immediately affected by this transaction, it certainly results in an outflow of funds.

As such, the term ‘fund’ stands for ‘Working Capital’.

Working Capital = Current Assets – Current Liabilities

Meaning of Flow

The term ‘flow’ means change or movement. Therefore, the term ‘Flow of Funds’ means ‘change in funds’ or ‘change in Working Capital’. In other words, ‘FLOW of Funds means increase or decrease in working capital.

Every Transaction will have one of the followings effect:

  • If a transaction results in the increase of working capital, it is said to be a source of funds.
  • If the transaction results in the decrease of working capital, it is said to be an application of funds.
  • If the transaction does not result in any change in the working capital, it is said that it does not result in the flow of fund.

Funds Flow Statement Meaning

Flow of fund means movement of fund.

I take the example of air; we can feel its movement or flow of air. Same thing is happen with fund, due to the activity of business fund is transfer from one asset to another assets. If fixed assets are converted into current asset or fixed liability is converted into current liabilities, these are the flow of fund.

But if current assets are changed with current assets or current assets are changed into current liabilities, then, there is no flow of fund because there is no change working capital.

Suppose, we get the money from debtor, this is not flow of fund because, working capital is not changed. Both items of current assets and when current assets change into current assets, there will not be change in working capital.

Fund Flow Statement Definition

A statement which summaries for the period covered by it, the changes in financial position including the sources from which the funds were obtained by the enterprised and the specific use to which the fund were applied. – Accounting Standard Board of ICAI

The fund flow statement describes the sources from which additional funds were derived and the uses to which these funds were put. – Robert N. Anthony

A statement of sources and application of funds is a technical device designed to analyse the changes in the financial conditions of business enterprise between two dates. – Foulke R. A

Thus fund flow statement is a statement which shows where funds come from and in what way they were used and the causes of changes in working capital. In other words it is a statement which shows the changes, inflow or outflow or the movement of fund.

Fund flow statements are known with different names

  • Statement of source and uses of funds
  • Summary of financial operations
  • Movement of working capital statement
  • Fund received and distributed statement
  • Fund generated and expended statement

Objectives of Fund Flow Statement

The main objectives of fund flow statement are:

  1. Analysis of Financial Position
  2. Evaluation of the Financing Capacity
  3. Instrument for Allocation of Resources
  4. Tool of communication to outside world
  5. Future guide
Objectives of Fund Flow Statement
Objectives of Fund Flow Statement

Analysis of Financial Position

The basic purpose of preparing the statement is to have a rich insight into where the funds were obtained and used in the past. In analyzing the financial position of the firm the funds flow statement answers to such questions as:

  • Where were the net current assets of the firm down, though the net income was up or vice versa?
  • How was it possible to distribute dividends in absence of or in excess of current income for the period?
  • How was the expansion in plants and equipment financed?
  • How was the sale proceed of plant and machinery used? How were the debts retired?
  • What became to the proceeds of shares issues or debentures issued?
  • How was the increase in working capital financed?
  • Where did the profits go?

Evaluation of the Financing Capacity

One important use of the statement is that it evaluates the firms financing capacity. The analysis of sources of funds reveals how the firm had financed its development project in the past, from internal sources or from external sources. It also reveals the rate of growth of the firm.

Instrument for Allocation of Resources

In modern large scale business, available funds are always short for expansion programs and there is always a problem of allocation of resources.

The amount of funds to be available for these projects shall be estimated by the finance manager with the help of funds flow statement. This prevents the business form coming a help less vision of unplanned action.

Tool of communication to outside world

Funds flow statement helps in gathering the financial states of business. In the present world credit financing it provides useful information to bankers, creditors, financial institution and governments regarding amount of the loan required, its purpose, the terms of repayment and sources for repayment of loan etc.

It carries information regarding firms’ financial policies to the outside world.

Future guide

The management can formulate its financial policies based on information gathered from the analysis of such statement. Financial manager can rearrange the firms financing more affectivity on the expected changes in trade payables and the various accruals.

In this guide the management in arranging it’s financing more effectively. Funds statement supplies valuable information to the management and aid material in planning for expansion in dividend polices and other major programs. If handled properly, it gives information which is not available elsewhere.

Sources of Fund

Sources of fund are indicated by increase in liability and decrease in assets. The main sources of funds are:

  1. Funds from Operations
  2. Issue of Shares
  3. Issue of Debenture and raising of loan
  4. Sale of Fixed (non-current) Assets and Long-term
  5. Non Trading Receipts
  6. Decrease in Working Capital
Sources of Fund
Sources of Fund

Funds from Operations

Profits resulting from business operations is most important source of funds. Computation of funds from operations has already been discussed.

Issue of Shares

When Shares are issued for cash they are source of funds. But when bonus shares are issued or shares are issued for some other consideration like fixed asset than it is not a source of funds.

Issue of Debenture and raising of loan

Issue of debentures or raising loans (long term) results in to flow of funds. The inflow of funds is the actual proceeds from the issue of such debentures or raising of loans, i.e. including the amount of premium or excluding discount, if any.

However, loans rose for consideration other than a current asset, such as for purchase of building, will not constitute inflow of funds because in that case the accounts involved are only fixed or non-current.

Sale of Fixed (non-current) Assets and Long-term

When any fixed asset like land, building, plant and machinery etc. are sold it generates funds. However, it must be remembered that if one fixed asset is exchanged for another fixed asset, it does not constitute an inflow of funds because no current assets are involved.

Non Trading Receipts

Any non-trading receipt like dividend received, refund of tax, rent received, etc. also increases funds and is treated as a sources of funds because such an income is not included in the funds from operations.

Decrease in Working Capital

If the working capital decreases during the current period as compared to the previous period, it means that there has been a release of funds from working capital and it constitutes a source of funds.

Applications or Uses of Funds

Applications of fund are indicated by decrease in liability and increase in assets. The main uses of funds are:

  1. Funds lost in operations ( Balance negative in second step )
  2. Redemption of preference share capital
  3. Redemption of debentures
  4. Repayment of long term loans
  5. Purchase of long term loans
  6. Purchase of long term investments
  7. Non trading payments
  8. Payment of tax
  9. Payment of dividends
  10. Increase in working capital (as per schedule of changes in working capital)

Difference Between Fund Flow Statement and Balance Sheet

  1. Fund Flow Statement shows the changes in working capital between two dates while Balance Sheet shows the financial position of a business on a particular date.

  2. Fund Flow Statement incorporates items casing change in working capital while Balance Sheet incorporates the balance of real and personal accounts.

  3. Fund Flow Statement is basically an analytical tool and therefore, it is very good for decision making while Balance Sheet is not an analytical tool and it is simply a summary of assets and liabilities on a particular date.

  4. Fund Flow Statement is prepared for the use of internal management; hence its publication is obligatory while Balance Sheet is prepared for the use of external parties of the business, hence its publication is mandatory.

Importance of Fund Flow Statement

The fund flow statement provides the information regarding changes in working capital of an organization for a particular period.

Therefore, we say that the importance of fund flow statement are as follows:

  • Funds flow statement reveals the net result of operations done by the company during the year.

  • In addition to the balance sheet, it serves as an additional reference for many interested parties like creditors, suppliers, government etc. to look into financial position of the company.

  • It shows how the funds were raised from various sources and also how those funds were put to use in the business, therefore it is a great tool for management when it wants to know about where and from funds were raised and also how those funds got utilized into the business.

  • It reveals the causes for the changes in liabilities and assets between the two balance sheet dates therefore providing a detailed analysis of the balance sheet of the company.

  • Funds flow statement helps the management in deciding its future course of plans and also it acts as a control tool for the management.

  • Helps in the evaluation of alternative finance and investments plan;

  • 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 statements.

  • Helps the management of companies to forecast in advance the requirements of additional capital and plan its capital issue accordingly.

  • Help in the planning process of a company

  • Helps in analysis of financial operations.

  • Helps in formulation of realistic dividend policy.

  • Helps in proper allocation of resources.

  • Helps in appraising the use of working capital.

  • It helps knowing the overall creditworthiness of a firm.

Limitation of Fund Flow Statement

The funds flow statement has a number of uses, however it has certain limitation of fund flow statement also which are as follows:

  1. Ignores Certain Non-fund Transactions
  2. Reveals Only Changes in Working Capital & Not in Cash Position
  3. Historical in Nature
  4. Doesn’t Provide Evidence of Change in a Financial Position
Limitation of Fund Flow Statement
Limitation of Fund Flow Statement

Ignores Certain Non-fund Transactions

It ignores certain non-fund transactions (such as issue of shares in consideration of purchase of fixed assets) which have equal bearing on the financial position of the firm just like other fund transactions.

Reveals Only Changes in Working Capital & Not in Cash Position

It reveals only the changes in working capital and does not show the changes in cash position. It is possible that there is sufficient working capital and yet the firm may be unable to meet its current liabilities due to shortage of cash. It may be due to sizeable piling up of inventories and an increase in debtors. Hence, a cash flow statement has to be prepared.

Historical in Nature

It is historical in nature because it reports what has happened in the past. It is quite difficult to predict the future operations on the basis of past records.

Doesn’t Provide Evidence of Change in a Financial Position

Since it is based on opening and closing balance sheets and the profit and loss account, it is not a original statement which can provide an original evidence to the change in financial position.

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