1. Chapter Introduction

2. Funds Flow Statement: Objectives

3. Preparing Funds Flow Statement

4. Inflow & Outflow of Funds

5. Funds from Operation

6. Working Capital: Schedule

 

 

1. Chapter Introduction:

The term funds may be used differently depending on the users' purpose. Literally, it means a supply that can be drawn upon.

Funds flow is used to refer to changes in or movement of current assets and current liabilities. This movement is of vital importance in understanding and managing the operations of a business.

2. Funds Flow Statement: Objectives:

 

Q. What is a Funds Flow Statement? (Jan. 01, June 02)

What are the objectives of Funds Flow Statement?

Funds Flow Statement consists three terms Funds, Flow and Statement

Where

Funds = Current Assets – Current Liabilities = Working Capital

Flow = Changes

A statement, which shows ‘Flow of Funds’ or ‘Changes in Working Capital’ is called "Funds Flow Statement".

Funds Flow Statement is prepared to workout the sources from where the additional funds have been received during the year and for what purposes these funds have been applied.

According to Smith Brown, "Funds Flow Statement is prepared in summary form to indicate changes (and trends if prepared regularly) occurring in items of financial condition between two different balance sheet dates."

According to R.N. Anthony, " Funds Flow Statement is a statement prepared to indicate the increases in the cash resources and the utilisation of such resources of a business during the accounting period."

Objectives of Funds Flow:

Profit & Loss Account and Balance Sheet are not able to give answer to some basic questions. For this purpose Funds Flow Statement is prepared. According to Perry Mason who points out in AICPA Research Study No. 2 that without such a statement, the following questions will remain unanswered:

1. Where did profit go?
2. Why were dividends not larger?
3. How was it possible to distribute dividends in excess of current earnings or in the presence of net loss for the period?
4. Why were the net current assets down although the net income is up?
5. How is that the net current assets are up even though there was a net loss for the period?
6. Why must money be borrowed to finance purchase of new plant and equipment when the required amount is exceeded by the "cash flow" (the sum of net income and depreciation)?
7. How was the expansion in plant and equipment financed?
8. What happened to the proceeds of the sale of plant and machinery resulting from a contraction of operation.
9. How was the retirement of debt accomplished?
10. What became of the assets derived from an increase in out-standing capital stock?
11. What became of the proceeds of the bond issue?
12. How was the increase in working capital financed?

3. Preparing Funds Flow Statement:

 Q. Define the terms ‘Fund’ and ‘Flow’ in the context of the funds flow statement. How is a funds flow statement prepared? (Jan. 01, June 02)

 

Meaning of the term ‘Fund’: - The term ‘Fund’ has been assigned different meanings by different people. In narrow sense ‘Funds’ means cash and Bank balance. To many people funds is nothing but having the net effect of various business events on the basis of cash. This explains the trend towards the preparation and presentation of "Cash Flow Statement" in published report of accounts.

But in wider sense the term ‘Fund’ is the sum of cash and assets, which are easily convertible into cash minus current liabilities. In other words ‘Fund’ means excess of current assets over current liabilities. Where current assets include cash in hand, cash at bank, bills receivable, sundry debtors, stock, marketable securities and prepaid expenses etc. The current liabilities include sundry creditors, bills payable, outstanding expenses, short-term loans and bank overdraft etc.

Funds = Current Assets – Current Liabilities = Working Capital

Meaning of the term ‘Flow’: - The term ‘Flow’ means change. Therefore flow of funds means change in working capital. The change in funds may be either positive or negative. It may be inflow of funds or outflow of funds.

Preparation of Funds Flow Statement:

A funds flow statement is basically prepared from non-current items of the balance sheets, prepared at the end of two accounting periods. It takes into account the sources and uses of funds during that accounting period. The major sources and applications of funds are as under

Funds Flow Statement

Example: The Balance Sheets of X Ltd. as on Dec. 31, 2004 and Dec. 31, 2005 were as follows: Question for practice

1. Rs. 50,000 depreciation has been charged to Plant & Machinery during the year 2005.
2. A piece of machinery costing Rs. 12,000 (Depreciation provided thereon Rs. 7,000) was sold at 60% profit on book value.

Required: - Prepare Funds Flow Statement.

Solutions :

Funds Flow Statement

for the year ending on 31^st December 2005

 

Schedule of Changes in Working Capital

 

Workings

Adjusted Profit & Loss Account

Note:  Book Value of Machinery sold = Original Cost – Depreciation provided

= Rs. 12,000 – Rs. 7,000 = Rs. 5,000.

Profit on Sale of Machinery = 60/100 x Rs. 5,000 = Rs. 3,000.

Therefore, Machinery sold for Rs. 8,000 (i.e. Rs. 5,000 + Rs. 3,000)

4. Inflow & Outflow of Funds:

Flow of fund takes place whenever there is change in working capital. This change may be either inflow or outflow of funds. There are a few examples of inflow and outflow of funds:

Inflow of Funds

Issue of Equity Share Capital

Issue of Preference Share Capital

Issue of Debentures/Long term Loans

Premium on issue of shares/debentures

Sale of Investments

Sale of Fixed Assets

Outflow of Funds

Redemption of Preference Share Capital

Redemption of Debentures

Repayment of Long term Loans

Premium on redemption of preference shares/debentures

Purchase of Investments/Fixed Assets

Dividend Paid

Taxes Paid

Drawings by proprietor/partner

 

Q. Distinguish between:

1. Funds Flow Statement and Position Statement i.e. Balance Sheet
2. Funds Flow Statement and Profit & Loss Account
3. Funds Flow Statement and Schedule of Changes in Working Capital

 

a.    Funds Flow Statement and Position Statement i.e. Balance Sheet

Basis of Difference	Balance Sheet	Funds Flow Statement
Objective	A balance sheet is prepared in order to show the financial position of a business at a particulars date.	A funds flow statement is prepared in order to show the overall inflow or outflow of working capital during a period of time.
Incorporation	A balance sheet incorporates all assets and liabilities of the business on a particular date.	A funds flow statement incorporates the different sources and application of funds during a period.
Basis	The balance sheet is prepared on the basis of balances of ledger at the end of a particular period.	Funds flow statement is prepared on the basis of Profit & Loss A/c, Balance Sheet and other additional information.
Format	A balance sheet is prepared in a prescribed format by Indian Companies Act.	There is no prescribed format for preparation of funds flow statement.
Concept	A balance sheet is based on stock concept. It shows the position of assets and liabilities on a particular date.	A funds flow statement is based on flow concept. It shows the causes for changes in working capital during a period of time.
Compulsion	It is compulsory for a company to prepare and present its balance sheet at the time of its general meeting.	It is not compulsory for a company to prepare and present funds flow statement.

b.    Funds Flow Statement and Profit & Loss Account

Basis of Difference	Profit & Loss Account	Funds Flow Statement
Objective	Profit & Loss A/c is prepared to workout net profit or net loss of the business.	A funds flow statement is prepared in order to show the overall inflow or outflow of working capital during a period of time.
Contents	Profit & Loss A/c is prepared on the basis of nominal accounts.	Funds flow statement is prepared on the basis of non-current assets and liabilities.
Compulsion	It is compulsory for a company to prepare its Trading and Profit & Loss A/c at the end of its accounting period.	It is not compulsory for a company to prepare funds flow statement.
Capacity	Profit & Loss A/c is prepared in order to show the performance of business activities.	Funds flow statement helps in financial activities of a business.
Tool of financial analysis	Profit & Loss A/c is one of the basic financial statements, which provides information for analysis of financial statement.	Funds flow statement is an important tool of analysis of financial statement.

 

c.     Funds Flow Statement and Schedule of Changes in Working Capital

 

 

Basis of Difference	Schedule of Changes in Working Capital	Funds Flow Statement
Objective	Schedule of changes in working capital is prepared to workout the net increases or decreases in working capital.	A funds flow statement is prepared in order to show the overall inflow or outflow of working capital during a period of time.
Basis	Schedule of changes in working capital is prepared on the basis of current assets and current liabilities.	Funds flow statement is prepared on the basis of Fixed Assets and Fixed Liabilities.
Contents	Schedule of changes in working capital is prepared only with the help of two Balance sheets.	Funds flow statement is prepared with the help of two balance sheets, profit & loss account and

5. Funds from Operation

Funds from Operation = Net Sales – Cost of goods sold – Operating Expenses.

Funds from operation means Operating Profit, which is calculated after deducting cost of goods sold and operating expenses from the amount of net sales.

Funds from Operation may also be calculated in the following manner:

			Rs.
	Net Profit (for the current year)		XXX
	Add: Non-cash and non-operating items like
	Depreciation		XXX
	Profit transfer to General Reserve/other Reserves		XXX
	Profit transfer to Sinking Fund/other Funds		XXX
	Provisions made during the year (Except provision on debtors)		XXX
	Loss on sale of Investment		XXX
	Loss on sale of Fixed Assets		XXX
	Proposed Dividend		XXX
	Interim Dividend		XXX
	Premium on Redemption of Preference Shares/Debentures		XXX
	Writing off:		XXX
	Goodwill		XXX
	Preliminary Expenses		XXX
	Discount on issue of shares and debentures		XXX
	Patent Right/Copy Right/Trade Marks		XXX
	Underwriting Commission		XXX
			XXX
	Less: Non-cash and non-operating incomes like
	Gain on sale of Investment		XXX
	Gain on sale of Fixed Assets		XXX
	Appreciation		XXX
	Rent from Tenants		XXX
	Interest/Dividend received		XXX
	Refund of Tax		XXX
	Excess provision written back etc.		XXX
			XXX
	Funds From Operation		XXX

6. Working Capital: Schedule

Schedule of changes in working capital is prepared on the basis of current assets and current liabilities given in the balance sheet for two years. It is prepared in the following manner:

	Particulars		Previous Year Rs.		Current Year Rs.		Increase Rs.		Decrease Rs.
	Current Assets:
	Cash in hand		XXX		XXX
	Cash at Bank		XXX		XXX
	Bills Receivable		XXX		XXX
	Sundry Debtors		XXX		XXX
	Stock		XXX		XXX
	Accrued Income		XXX		XXX
	Marketable Securities		XXX		XXX
	Prepaid Expenses		XXX		XXX
			XXX		XXX
	Current Liabilities:
	Sundry Creditors		XXX		XXX
	Bills Payable		XXX		XXX
	Bank Overdraft		XXX		XXX
	Outstanding Expenses		XXX		XXX
	Amounts received in advance		XXX		XXX
			XXX		XXX
	Working Capital (CA – CL)
	Net increase/decrease in working capital
			XXX		XXX		XXX		XXX

 

NOTE:

Increase in the amount of current asset will be shown in the increase column and decrease in the amount of current assets will be shown in decrease column. Decrease in the amount of current liabilities will be shown in the increase column and increase in the amount of current liabilities will be shown in the decrease column.If the total of increase column is more than that of the decrease column, net result will be net increase in working capital and if the total of decrease column is more than that of the increase column, result will be net decrease in working capital.