The Fund Flow Statement is beneficial for performing long-term analysis. It is an extremely important tool in the hands of management for evaluating the company’s financial and operational performance. This article helps understand the Fund Flow Statement’s application and benefits.
What is a Fund Flow Statement
Fund flow statement is prepared to analyse the reasons for changes in a company’s financial position between two balance sheets. It projects the inflow of funds (source of funds) and outflow of funds (application of funds) during a specific period of time.
In other terms, a fund flow statement is created to explain the working capital changes in the company.
Purpose of Fund Flow Statement
Even though every company prepares a profit & loss statement and balance sheet, a fund flow statement is still required as its purpose is different from the former two financial statements. While a P&L statement and a balance sheet show the numbers of two financial years – current & previous, they would not explain why the reasons for change between the two time periods.
It is where a fund flow statement comes in to picture. A fund flow statement provides two critical pieces of information – sources of funds and the application of funds. From where does the money come from, and where it is being spent. With this, the company has a better idea about its income-generating sources and expenditure.
Key Elements of a Fund Flow Statement
As mentioned earlier, a fund flow statement contains sources of funds and applications of funds.
- Sources of funds received from owners and other parties.
- Applications of funds used for the purchase of fixed and current assets.
How To Prepare Fund Flow Statement?
Step 1: Prepare Statement of Changes in Working Capital
To begin preparing the fund flow statement, the changes in working capital must be prepared. There are various possible explanations for changes in a company’s working capital position, a few of which have been described below: –
- Acquisition of fixed assets or long-term investments without the need to raise long-term capital
- Dividends paid in excess of profits obtained
- Credit extension to customers
- Without raising Long Term Resources, repayment of a Long Term Liability or redemption of Preference Shares
Step 2: Prepare Operational Funds
The following step is to prepare the funds generated solely by the business’s operating activities and not by its investing/financing activities. If we make a profit, this is a source of cash; if we lose money, this is an application of funds.
- In this statement, profit/loss will be deducted from the profit & loss account. Then, certain profit/loss adjustments will be necessary.
- Accrual accounting is used to create profit and loss statements. Non-cash expenses such as depreciation, bad debt, and any other write-offs are also factored into the real profit or loss calculation.
- We will recoup or deduct such non-cash expenses to arrive at the cash profit/loss.
Step 3: Fund Flow Statement Preparation
When preparing the fund flow statement, it is important to describe the sources and uses of funds in detail so that the sources of funds and the uses of these funds are clearly understood. The statement of funds sources and applications and the statement of changes in financial position are two terms that are frequently used to refer to this document.
Sources of Funds in Fund Flow Statement
- Cash Issue of Shares and Debentures: This is the entire sum obtained from the issue of shares or debentures. However, no cash inflow means no bonus shares or debt conversion into equity shares or vendor shares.
- Long Term Loans: The amount earned from raising Long Term Loans is indicated here. Short Term Loans are not shown here because they were treated in the Statement of Changes in Working Capital.
- Investments and other Fixed Assets Sale: This section shows the total amount obtained from the sale of investments and other fixed assets.
- Operational Funds: The Operational Funds determined in Step II must also be shown here.
- Change in Working Capital: This is the statement’s balancing figure.
Applications of Funds in Fund Flow Statement
- Investments in Fixed Assets and Investments: The Cash Payment made for the acquisition of Fixed Assets and Investments is considered an application of Funds.
- Acquisition of Fixed Assets and Investments: However, if the purchase is accomplished through the issuance of shares or debentures, the transaction will not be considered an application of funds. In the same way, if the purchases are made on credit, they will not be considered fund requests.
- Redemption of Debentures and Preference Shares, as well as the repayment of the loan: In this case, the payment made, including the Premium (minus the Discount), is to be considered as a fund application.
- Payment of Dividend and Tax: If the provisions are omitted from Current Liabilities and Current Provisions are put back to profit to define the “Funds from Operations,” the payments of dividend and tax are to be treated as applications of funds.
- Increase in Working Capital: This would be the Statement’s Balancing Figure, and it would result from the adjustment in the Working Capital Statement.
Fund Flow Statement Format
|Sources of Funds||Application of Funds|
|Capital||xxx||Funds utilised in creation of Fixed assets||xxx|
|Debts||xxx||Funds utilised in creation of other Non- current assets.||xxx|
|Funds generated from operationsSale of assets (if any)||xxx||Funds utilised in repaying existing loans.||xxx|
|Funds utilised for paying dividends, taxes||xxx|
|· (Bal.fig) Excess usage of funds over sources.|
[Decrease in working capital]
|*(Bal.fig) Excess of Funds over application of funds –|
[ Increase in working capital]
Uses Of Fund Flow Statement
- It helps to explain to fund managers why the company is experiencing liquidity constraints despite profitable operations as represented in the profit and loss statement.
- On the contrary, it enables managers to comprehend how a business can remain financially sound despite operating deficits.
- A fund flow statement enables us to determine whether short-term funds are being utilised for long-term investments.
Difference Between Fund Flow Statement And Cash Flow Statement
The Fund Flow Statement and the Cash Flow Statement are both financial statements that are used to analyse the individual transactions of a corporation. However, as discussed below, there are some differences between the two: –
- The Fund Flow Statement is created using the Accrual Accounting System. The Cash Flow Statement, on the other hand, solely considers transactions involving cash or cash equivalents.
- The Fund Flow Statement analyses the Sources and Uses of Long-Term Capital, and the resulting Net Increase or Decrease in Long-Term Capital is reflected in the firm’s Working Capital. The Cash Flow Statement determines the Cash Flow of Funds from Operations purely based on the increase or decrease in current assets or liabilities.
- For long-term financial planning, the Fund Flow Statement is more advantageous. Cash Flow Analysis is more beneficial for identifying and resolving a business’s financial problems.
- The Statement of Cash Flows reconciles the monies generated by diverse sources with their varied uses. The Opening Cash Balance is the starting point for the Cash Flow Statement, and the Closing Cash Balance is the ending cash balance.
Limitations Of Fund Flow Statement
(a) A fund flow statement cannot depict continual changes in financial activity, such as changes in working capital.
(b) It is not an original statement because it is based on financial statements (i.e. Income Statement and Balance Sheet).
(c) Because it is a projected statement, a projected Fund Flow Statement does not necessarily give highly accurate projections of the financial condition.
(d) It is not intended to be used in place of financial statements, specifically the Income Statement and Balance Sheet.
It only provides information about the change in the Working Capital situation, which is dependent on the financial statements data.
(e) The Cash Flow Statement, i.e. changes in cash position, is more significant or informative than the Fund Flow Statement’s changes in working capital.