Funds Flow Analysis

The Funds flow analysis explains the various sources from which funds are raised and uses to which funds are put. It shows the change in assets and liabilities from the end of one period of time to the end of another period of time (i.e. between two Balance sheet dates). An analysis of statement helps us in answering question such as what is the amount of funds generated from Operations. How were the Fixed Assets of Organisation Financed? Whether the liquidity position of the organization increased? Etc.

Concept of Funds

The term fund has been defined and interpreted differently by different experts. Broadly the term fund refers to all the financial resources of the company. On the other extreme, fund has been understood as Cash only. However, the most acceptable meaning if funds is working capital. Working capital is the excess of current assets over current liabilities.

Concept of Flow

The flow of funds refers to transfer of economic values from one asset or equity to another. When funds mean working capital, flow of funds refers to changes in assets and liabilities, which cause a change in working capital of the organisaton. To identify a flow of funds, we have to understand the difference between current and Non – current Accounts.

Current Accounts and Non – Current Accounts.

Any account which is either current asset or a current liability is a current account. An account which is neither current asset nor current liability is Non – Current Account.

The concept of current accounts is important as fund implies working capital, which is the difference between current assets and current liabilities. If there is a change in a current account, there is a Possibility of Flow of funds If there is no change in any of the current accounts, there is cannot be any flow of funds.

General Rule

1. Transactions that involve only current Accounts do not result in a flow. In other words, if both the accounts getting impacted on account of a transaction are Current accounts there is no change in position of funds.
2. Similarly, transactions that involve only Non – Current Accounts also do not result in a flow.
3. Transactions that involve one current account and one non – current account results in a flow of funds.

Examples:

1. Cash Purchases Rs.10,000/-

In this transactions two current accounts are affected i.e. Cash & Stock. Firstly there is a decrease in cash. Therefore, C. Assets will fall by Rs10,000/-. However there is increase in Stock Therefore, C .Assets will rise by Rs.10,000/-. There is no effect in Current Assets and Working Capital. So, there is no flow of Funds.

2. Bills Payable accepted Rs.5,000/-

In this transaction two Current Liabilities are affected. Creditors are reduced by Rs.5,000/-. However, Bills Payable increase by Rs.5,000/-. No net change in Current Liabilities and Working Capital. So, there is no flow of funds.

3. Cash Paid to Creditors Rs.2,000/-

In this transaction, cash gets reduced by Rs.2,000/-. Thus, C.A decreased by Rs.2,000/-. However, creditors are also reduced by Rs.2,000/-. Consequently, C.L decrease by Rs.2,000/-. Since Working Capital is the difference in C.A and C.L, it remains same as the change in C.A is equal to the change in C.L There is no flow of funds.

4. Issue of Bonus shares to equity share holders out of General Reserve in the ratio 1:1

The effect of this transaction is the Equity share capital of the company gets doubled. However, the reserves of the company come down. Both accounts are non-current accounts. The current accounts are not affected. There is no flow of funds.

5. Land Purchased for Rs.3,00,000/-, payment made by cheque.

In this account cash at Bank, a current account gets reduced. Consequently, there is a fall in working capital to the extent of Rs.3,00,000/-. A new asset, land is acquired. However, it being a non-current account, it does not affect the working capital. Therefore the net affect is a fall in working capital to the extent of Rs.3,00,000/-. There is an outflow of funds.

6. Sale of Building for Rs.10,00,000/-

In this transaction, the amount received on sale is current asset. The current asset increased by Rs.10,00,000/-. Consequently, working capital increased by Rs.10,00,000/-. The business has to part with an asset worth Rs.10,00,000/-, but building being a non-current account, it does not affect working capital. There is an inflow of funds.

Preparation of Funds Flow Statement

The funds flow statement is prepared to reflect the changes in the financial position of an organization during a particular period. As such, Balance sheets of the organization at the beginning and end of the particular period are the basic documents that are needed for preparation of funds flow statement

The fund flow statement can also be presented in a vertical form. In such a case, all sources are listed down, totaled and then all Applications are listed at one place and totaled. The totals should be the Increase and decrease in Working capital.

Statement of changes in Working Capital

This statement follows the statement of Sources and Application of Funds. The primary purpose of the statement is to explain the net change in Working Capital, as arrived in the Funds Flow Statement. In this statement, all current Assets and Current Liabilities are individually listed. Against each account, the figure pertaining to that account at the beginning and at the end of accounting period shown. The net change in its position also shown. The changes taking place with respect to each account should and up to equal the net change in working capital, as shown by the Funds Flow statement.

While entering the effect of change in a current account on working capital, the following rules must be followed.

1. An increase in Current Assets means an increase in Working Capital;
2. An decrease in Current Assets means an decrease in Working Capital;
3. An increase in Current Liabilities means an decrease in Working Capital;
4. An decrease in Current Liabilities means an increase in Working Capital;