30 Fund Flow Statement: meaning, importance and limitation of Fund Flow statement
Deepika Gautam
LEARNING OBJECTIVES:
After going through the module, students may be able to understand the meaning of fund flow statement, objectives of preparing it. Also, the format of fund flow statement and the steps for preparing the statement is also made clear, along with some of its limitations.
INTRODUCTION:
The term “fund” has different meanings. In a narrow sense it means cash and the statement of changes in financial position (prepared on cash basis) is termed as cash flow statement. In a wider sense, the term fund refers to working capital and the statement which is prepared to know the changes in working capital, (on accrual basis) is known as fund flow statement.
Every enterprise transacts during an accounting year in order to earn profits and survive in the competition. The dealing in various transactions leads to the inflow and outflow of cash, on regular basis. Every firm needs fund for two purposes: for its establishment and for carrying out its daily operations. Funds are needed for long term purposes and also for the short term needs such as payment of salaries, wages, day to day expenses etc. The funds or the portion of capital that is required for fulfilling the day to day operations of any business is termed as working capital. And maintenance of record regarding the source and utilization of working capital is must.
For this purpose, every organisation prepares a fund flow statement to analyse the reasons for the changes in their working capital and analyse the inflows and outflows of funds over a particular period. Fund flow statement is considered more useful for long term financial planning and for judging the operating as well as the financial performance of the company. Such an analysis proves to be of great help to the management, shareholders, creditors, investors etc as it provides the information that the balance sheet and profit and loss account fail to provide (i.e. the changes in financial position).
MEANING OF FUND FLOW STATEMENT:
As the name suggests, fund flow statement is the statement depicting the flow/changes of funds. It is a consolidated statement of all cross transactions that affect the changes in the working capital of an enterprise over the period. Cross transactions are those involving the current and non current accounts bringing a change in the working capital.
By fund flow we understand how the values of funds change from their initial figure to the final figure, between two balance sheet dates, i.e. the moment of funds between opening and closing dates of balance sheet. In other words, it is a statement disclosing the analytical information about different sources of funds and their utilisation in an accounting cycle. It is also termed as statement of sources & application of funds, movement of funds statement etc. With the help of fund flow statement one can analyse:-
1. The growth rate of firm
2. The financial needs of the firm
3. Sources to finance those needs
The changes in fund can be interpreted in two directions:
1. Funds flowing inwards : Inflow
2. Funds flowing out of the organisation : Outflow
1. Inflow/Source of Fund: If any change in the fund account value, results in an addition in the funds, it is termed as an inflow of fund. An increase in equity share capital, increase in reserves, decrease in value of fund asset etc would result into an inflow.
2. Outflow/Application of Fund: if the change in the fund account value, results in reduction in funds, it is termed as an outflow of fund. An increase in value of fixed assets, decrease in liability, decrease in reserves all result into an outflow.
NO FLOW OF FUNDS:
Some transactions may not bring any change in the fund position. Such transactions are involved within the business concern. Example: conversion of shares into debentures, machinery purchased and payment made in shares.
OBJECTIVES OF PREPARING A FUND FLOW STATEMENT:
Preparation of fund flow statement is done keeping in mind the following objectives:
1) To reveal the correct sources and application of funds: fund flow statement is prepared so as to find from where exactly the funds are coming in an organisation (i.e. sources of funds) and whether the acquired funds are being utilised properly with adequate consideration or not.
2) To find the sources from where funds are generated: it is made to reveal that how much fund is collected by disposing of fixed assets, how much by issuing shares/ debentures, how much from operating activities & how much from loans etc.
3) To help the management: an analysis done on the basis of fund flow statement, proves to be an important tool in the hands of management as it helps them to prepare budgets, formulate policies that will be adopted for future activities and to judge the financial position of the firm.
4) To know the exact amount of fund utilisation: the exact amount of funds being utilised/ used up is revealed from the preparation of fund flow statement. It becomes easy to find out how much have been used up in acquiring fixed assets, how much for repaying loans, and how much is used for paying taxes, dividend etc.
QUICK REVISION
▪ Fund flow statement revealing changes in the working capital of an organisation.
▪ Fund flow statement reveals the different sources of funds and the areas where it is being utilised.
▪ It is considered more useful for long term financial planning.
▪ Unlike balance sheet and profit & loss account it reveals the changes in financial position of enterprise.
▪ The changes in fund is interpreted in two directions: inflow and outflow.
▪ The fund flow statement occurs when a transaction bring a change in the current account and non current account simultaneously.
FORMAT OF FUND FLOW STATEMENT:
A fund flow statement can be prepared in two ways:
1. Statement form
2. T fo
Fund Flow Statement (Statement Form)
GENERAL RULES FOR PREPARING FUND FLOW STATEMENT:
Following are the general rules that need to be followed while preparing the fund flow statement, as they help in deciding whether there is an inflow of funds or outflow of funds.
1) Increase in the non current asset results into a decrease in working capital (outflow)
2) Decrease in non current asset means an increase in working capital (inflow)
3) Increase in non-current liabilities results into an increase in working capital (inflow)
4) Decrease in non-current liabilities results into decrease in working capital (outflow)
5) Changes in non-current assets and liabilities affect working capital.
STEPS IN PREPARING A FUND FLOW STATEMENT:
The following are the steps involved in the fund flow statement preparation:
1) By looking at the balance sheet figures of two consecutive dates, firstly a statement depicting the “fund from operations” is prepared. It is prepared by adding the Non fund/ Non operating items already debited to P&L Account, to the closing balance of P&L Account. And then subtracting the Non fund/ Non operating items already credited to P&L Account.
2) After which the “statement of changes in working capital” is prepared. The items are grouped up under the heads, current assets and current liabilities, and change in working capital (as increase or decrease) is stated individually for each item and then all the current assets and liabilities are summed up. After which their difference is calculated to reveal the Net Increase or Decrease in the Working Capital.
3) The last step is the preparation of fund flow statement. Depicting “Sources of Funds” on the left side and “Application of Funds” on the right side.
For deepening the knowledge about the steps in its preparation, a hypothetical example has been presented hereunder:
Example:
Balance Sheet
| Liabilities | Amount | Amount | Assets | Amount | Amount |
| (2013) | (2014) | (2013) | (2014) | ||
| Share Capital | 96100 | 106100 | Goodwill | 15000 | 13000 |
| General Reserve | 15000 | 17000 | Building | 50000 | 46900 |
| Profit & Loss Account | 20000 | 15000 | Machinery | 35000 | 34000 |
| Provision for taxation | 18000 | 19000 | Stock | 25000 | 24500 |
| Sundry Creditors | 9000 | 5000 | Sundry Debtors | 24000 | 26000 |
| Bills Payable | 7200 | 4300 | Cash at Bank | 7000 | 12000 |
| Provision for Doubtful Debts | 1700 | 2000 | Investments | 11000 | 12000 |
| TOTAL | 167000 | 168400 | TOTAL | 167000 | 168400 |
Additional Information:
1) Depreciation on machinery was Rs 5000 and on building Rs 3100
2) Interim dividend paid during 2014 was Rs 8000
3) Provision on taxation during 2014 is Rs 6000
STEP I:
The first step is to start up by preparing the fund from operations
Fund from Operations
| Particulars | Rs | Rs | |
| Net Profit (closing balance) | 15000 | ||
| Add: Non fund/ Non operating items already debited to P&L Account | |||
| Goodwill written off | 2000 | ||
| Depreciation on machinery | 5000 | ||
| Depreciation on building | 3100 | ||
| Interim dividend paid | 8000 | ||
| Transfer to general reserve | 2000 | 20100 | |
| 35100 | |||
| Less: Non fund/ Non operating items already credited to P&L Account | |||
| Net profit (opening balance) | 20000 | ||
| FUND FROM OPERATIONS | 15100 | ||
STEP II:
After preparing the statement of fund from operations, the next step is the preparation of schedule of changes in the working capital. It is essential to be prepared before preparing the fund flow statement.
Schedule of changes in working capital
| Particulars | 2013(Rs) | 2014(Rs) | Changes in Working Capital | |
| Increase | Decrease | |||
| (1)CURRENT ASSETS: | ||||
| Stock | 25000 | 24500 | 500 | |
| Sundry debtors | ||||
| Less: provision for doubtful debts | 22300 | 24000 | 1700 | |
| Cash balances | 7000 | 12000 | 5000 | |
| TOTAL (1) | 54300 | 60500 | ||
| (2)CURRENT LIABILITIES |
| Sundry creditors | 9000 | 5000 | 4000 | |
| Bills payable | 7200 | 4300 | 2900 | |
| Provision for tax | 18000 | 19000 | 1000 | |
| TOTAL (2) | 34200 | 28300 | ||
| Working capital (1-2) | 20100 | 32200 | ||
| Net increase in working capital | 12100 | 12100 | ||
| 32200 | 32200 | 13600 | 13600 | |
STEP III:
After attaining the statement of changes in worn=king capital, the final step involves the preparation of fund flow statement.
Fund Flow Statement
| Sources of Fund | Amount(Rs) | Application of fund | Amount(Rs) |
| Issue of share capital | 10000 | Purchase of machinery1 | 4000 |
| Funds from operations | 15100 | Purchase of investments | 1000 |
| Interim dividend paid | 8000 | ||
| Net increase in working capital | 12100 | ||
| 25100 | 25100 | ||
Working Notes:
1) Machinery Account
| To Balance b/d | 35000 | By Depreciation | 5000 |
| To Bank | 4000 | By balance c/d | 34000 |
| (Purchase of machinery balancing figure) | |||
| 39000 | 39000 | ||
QUICK REVISION
▪ There are two formats for the preparation of fund flow statement: statement form and the “T” form
▪ Before preparing fund flow statement, statement of fund from operations and statement of changes in working capital is prepared
▪ Net change in working capital is calculated by subtracting outflows from the inflows
SIGNIFICANCE/ IMPORTANCE OF FUND FLOW STATEMENT
Though financial statements reveal the financial strength of an enterprise, sometimes they are not enough for taking tough decisions for long term survival. In such a case, a fund flow statement is required so that by looking at the balance sheet values for consecutive two years, the management can find out the exact sources of funds and also reveal that where the funds are being utilised. Moreover from the fund flow statement analysis, management can easily find out that if working capital is available in adequate amount or not.
Following are the points of fund flow statement importance:
1) Realistic Dividend Policy:
Despite of having surplus profits, a firm may not be in a position to pay off its dividends due to lack of liquid resources. Here, fund flow statement helps in deciding as to from where the funds should be used up so as to pay dividends.
2) Proper Resource Allocation:
Every enterprise faces a problem of limited resources and so it tries to efficiently utilise its available resources to the best possible manner. Fund flow statement helps to decide about the proper allocation of business resources in a best possible manner.
3) Serves as a Future Guide:
Fund flow statement serves as a future guide for the management, i.e. the future needs of the funds for various purposes can be known well in advance. The future financial problem that might creep in the working of the business can be avoided by looking up at the fund flow statement and arranging funds for future, before-hand.
4) Reveals Changes in Working Capital:
It reveals the changes in the working capital level of a firm, as it depicts the inflows and outflows of the funds and calculates the changes in working capital by subtracting the amount of inflows and outflows.
5) Depicting firms ability:
The firm’s ability to pay interest, dividend and pay debts when become due can be revealed using a fund flow statement, also its ability to generate long term financing is revealed.
6) Helps in taking Decisions before Investing:
It helps the investors to determine about how the company has utilised the funds invested by them in the company and moreover by analysing the past and the present values and their changes, the investors can identify and discover potential drains on funds in the near future and whether to invest in the company or not.
7) Analysing the Financial Position:
The importance of fund flow statement lies in the fact that it helps to analyse the strengths and weaknesses and the financial operations of the firm. It reveals how the funds were obtained and used up in the past and how it impacted the firm’s liquidity, on the basis of which proper steps can be taken in the present and corrective actions can be applied in order to avoid any past mistakes (if any) in the future.
8) Tool of Communication with the Outside World:
Fund flow statement help in gathering information about the financial affairs of company and communicate it to the outside world. It provides useful information to the bankers, creditors, government etc. regarding the amount of loan required, terms of repayment of loan etc.
LIMITATIONS OF FUND FLOW STATEMENT
Despite of the importance of fund flow statement to the organisation, it suffers from various limitations as well:
1) A fund flow statement is not able to present a continuous change in financial activities, including working capital changes.
2) It is not a substitute of financial statements, it only highlights the changes in working capital which is dependent on data presented by the financial statements.
3) Cash flow statement i.e. changes in cash position, seems to be more important/ informative as compared to the changes in working capital.
4) Fund flow statement has to be used along with the financial statements, it cannot be used all alone.
5) It does not reveal cash position, therefore preparation of cash flow statement becomes must along with the preparation of fund flow statement.
6) Is historic in nature, i.e. reveals what had happened in the past only, and does not tell about the future. Only presumptions regarding future can be drawn out, which might prove to be wrong.
7) Lacks originality as it is just a rearrangement of data given in the financial statements, hence some companies avoid preparing a fund flow statement.
QUICK REVISION
▪ Fund flow statement helps in proper resource allocation, serves as a future guide, reveals changes in working capital and depicts firm’s ability.
▪ It acts as a communication tool with the outside world, helps in analysing the true financial position and helps investors in taking any decision regarding investing.
▪ Fund flow statement cannot be prepared alone, must be complemented with the financial statements, lacks originality, is historic in nature and often lacks originality.
SUMMARY
Organisations work for the generation of funds that can be used for the long term as well as short term purposes. The money generation may be the result of either cash inflow or cash outflow. Inflow means when there is an increase in the amount of funds, whereas outflow refers to the decrease in the amount of funds. “Funds”, in a broad sense means working capital, and the statement prepared to record the changes in working capital (inflow and outflow) is termed as the fund flow statement. Fund flow statement means changes in the value of funds depicting the sources from where the funds are generated, and the application of funds depicting where the funds are being utilised/ used up.
Sometimes, there may be cases of “No Flow” which means that some transactions may not bring any change in the fund position. Such transactions are involved within the business concern. Example: conversion of shares into debentures, machinery purchased and payment made in shares. Fund flow statement is often prepared with an objective to reveal the correct sources from where the funds are generated as well as application of funds, i.e. where they are used up. Also, it is prepared with an objective of helping the management in preparing budgets, formulating policies and judging the financial position of firm.
There are two formats available for the preparation of fund flow statement, statement form and the “T” form. And every firm before preparing a fund flow statement must prepare a Statement of fund from operations and a statement of changes in the working capital. These will act as a helping hand in the preparation of the fund flow statement. Preparing this statement has many benefits such as it serves as a future guide, reveals the changes in working capital, provides exactly where the funds are being used up, helps in analysing the financial position of the firm and serves as a tool of communication with the outside world. Fund flow statement is also affected by some of the limitations as it lacks originality, cannot be used alone i.e. has to be used along other financial statements, and is historic in nature i.e. tells about the past activities only. Despite of its limitations, firms present fund flow statement either on quarterly or half yearly or annual basis, and try to analyse the sources and application of the funds in the firm.
| you can view video on Fund Flow Statement: meaning, importance and limitation of Fund Flow statement | |
Few suggested readings to learn more:
- I.M. Pandey, “Financial Management”, Vikas Publishing, New Delhi
- Nitin Balwani, “Accounting and finance for Managers”, Excel Books, New Delhi
- Prasanna Chandra, “Financial Management – Theory and Practice”, Tata McGraw Hill, New Delhi
- S.Bhat, “Financial Management”, Excel Books, New Delhi
Points to Ponder:
1) Organisations work for the generation of funds that can be used for the long term as well as short term purposes.
2) The money generation may be the result of either cash inflow or cash outflow.
3) Inflow means when there is an increase in the amount of funds, whereas outflow refers to the decrease in the amount of funds.
4) “Funds”, in a broad sense means working capital, and the statement prepared to record the changes in working capital (inflow and outflow) is termed as the fund flow statement.
5) Fund flow statement means changes in the value of funds depicting the sources from where the funds are generated, and the application of funds depicting where the funds are being utilised/ used up.
6) Fund flow statement is often prepared with an objective to reveal the correct sources from where the funds are generated as well as application of funds, i.e. where they are used up.
- 7) Also, it is prepared with an objective of helping the management in preparing budgets, formulating policies and judging the financial position of firm.
- 8) There are two formats available for the preparation of fund flow statement, statement form and the “T” form.
- 9) Preparing this statement has many benefits such as it serves as a future guide, reveals the changes in working capital, provides exactly where the funds are being used up, helps in analysing the financial position of the firm and serves as a tool of communication with the outside world.
- 10) Fund flow statement is also affected by some of the limitations as it lacks originality, cannot be used alone i.e. has to be used along other financial statements, and is historic in nature i.e. tells about the past activities only.
- 11) Despite of its limitations, firms present fund flow statement either on quarterly or half yearly or annual basis, and try to analyse the sources and application of the funds in the firm.