Note on Funds Flow Statement: Flow & No flow of fund, differences & limitations

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Funds Flow Statement

Funds flow statement is a statement depicting all the various sources of funds from where they have been obtained as well as the applications to which those funds have been used on. After preparing the statement of changes in working capital and determination funds from operation, funds flow statement is finally prepared. But, before preparing funds flow statement, the concept of the flow of fund and no flow of fund should be understood.

Flow of Fund

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Source: www.patternsmart.com

The term ‘Flow of Fund’ refers to the changes in working capital or the movement or changes of funds. In other words, while a transaction is taking place, any increase or decrease in funds or working capital is called Flow of Fund. If the funds or working capital increases, it is treated as the Inflow of fund or sources of fund. On the other hand, if the funds or working capital decreases, it is called the outflow of fund.

No Flow of Fund

When a transaction affects fixed assets and fixed liabilities or current assets and current liabilities, the flow of funds does not occur. This kind of transaction flow is called no flow of fund and it occurs only between non-current accounts. Some examples of such transactions which do not affect the flow of funds or which are not recorded in the fund's flow statement are:

  • Collection from debtors or Payment to creditors
  • Purchase or Sales of inventory in cash or credit
  • Purchase or Sales of marketable securities
  • Exchange of fixed assets
  • Purchase of fixed assets by the issue of shares
  • Conversion of debentures into shares, etc.

Analysis of Non-Current Assets and Liabilities

To prepare funds flow statement, it is a must to take non-current assets and non-current liabilities into consideration. Because they are shown in the statement of changes in working capital, it is very important to know about their changes and their effects.
Effects of changes in non-current assets:

Assets

Changes

Effect

Funds Flow Statement

Fixed assets

(with depreciation)

Increase

Purchases of assets

Uses side

Decrease

Depreciation on assets

Add or Dr. side

Fixed assets

(without depreciation)

Increase

Purchases of assets

Uses side

Decrease

Sales of assets

Sources side

Intangible assets

Increase

Purchases

Uses side

Decrease

Written off/ Amortization

Add or Dr. side

Fictitious assets

Increase

Payment/

Uses side

Decrease

Written off/ Amortization

Add or Dr. side

Investment

Increase

Additional investment

Uses side

Decrease

Sales of investment

Sources side


Effects of changes in non-current liabilities:

Liabilities & Capital

Changes

Effect

Funds Flow Statement

Preference share capital

Increase

Issue (sources)

Sources side

Decrease

Redemption (uses)

Uses side

Long-term debt

Increase

Additional loan (sources)

Sources side

Decrease

Repayment of loan (uses)

Uses side

Share premium

Increase

Increase with issue (sources)

Sources side

Decrease

Utilization to fictitious assets

No source no use

(respective accounts)

Reserve & surplus

Increase

Transfer of profit from P/L a/c

Add or Dr. side

Decrease

Use of reserves

Less or Cr. side

Equity share capital

Increase

Issue of share

Sources side


Format

Funds flow statement can be prepared in 2 formats; horizontal format or vertical format.

  1. Horizontal format

ABC Company Ltd.
Funds Flow Statement

Sources of fund

Rs.

Uses of fund

Rs.

Working capital decreased(step 1)

Funds from operation (step 2)

Issue of shares (increase)

Increase in share premium

Issue of debentures (increase)

Sales of fixed assets

Sales of fixed premium

Sales of investment

Refund of tax

Loan taken (increase)

Increase in public deposit

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

Working capital increased(step 1)

Loss from operation (step 1)

Redemption of share

Redemption of pref. share

Redemption of debentures

Purchase of fixed assets

Increase in intangible assets

Additional investment

Tax paid

Payment of loan (decrease)

Dividend paid

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

Total

xxx

xxx

  1. Vertical format

ABC Company Ltd.
Funds Flow Statement

Particulars

Rs.

Sources:Funds from operation (step 2)

· Issue of shares (increase in share capital)

· Increase in share premium

· Issue of debentures (increase in debenture)

· Sales of fixed assets

· Sales of fixed premium

· Sales of investment

· Refund of tax

· Loan taken (increase in loan)

· Increase in public deposit

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

Total [A]

xxx

Uses:Loss from operation (step 1)

· Redemption of share (decrease)

· Redemption of preference share

· Redemption of debentures

· Purchase of fixed assets

· Increase in intangible assets

· Additional investment

· Tax paid

· Payment of loan (decrease)

· Dividend paid

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

Total [B]

xxx

Net increase/ decrease in working capital [A-B]

xxx/ (xxx)

Illustration:

Particulars

Amount (Rs.)

Decrease in net working capital

Funds from operation

Issue of equity share capital

Share premium increased

Purchase of furniture

Purchase of plant & machinery

Tax paid

Redemption of debenture

Repayment of mortgage loan

Interim dividend paid

1,30,000

2,10,000

3,00,000

60,000

30,000

1,75,000

90,000

1,50,000

1,35,000

1,20,000

Solution:

Funds Flow Statement
for the year ending 31st December 2015

Sources of fund

Rs.

Uses of fund

Rs.

Decrease in working capital

Funds from operation

Issue of equity share capital

Share premium increased

1,30,000

2,10,000

3,00,000

60,000

Redemption of debentures

Purchase of furniture

Purchase of plant & machinery

Tax paid

Payment of mortgage loan

Dividend paid

1,50,000

30,000

1,75,000

90,000

1,35,000

1,20,000

Total

7,00,000

7,00,000

Alternatively,


Funds Flow Statement
for the year ending 31st December 2015

Particulars

Rs.

Sources:Funds from operation

· Issue of equity share capital

· Share premium increased

2,10,000

3,00,000

60,000

Total [A]

5,70,000

Uses:Redemption of debentures

· Purchase of furniture

· Purchase of plant & machinery

· Tax paid

· Payment of mortgage loan

· Dividend paid

1,50,000

30,000

1,75,000

90,000

1,35,000

1,20,000

Total [B]

7,00,000

Net decrease in working capital [A-B]

(1,30,000)


Differences between Funds Flow Statement and Balance Sheet:

Funds Flow Statement

Balance Sheet

Funds Flow Statement is a statement of significant changes in the assets, liabilities and capital accounts.

Balance Sheet refers to the statement prepared at the end of accounting period, which incorporates assets and liabilities.

Funds Flow Statement is prepared on the basis of Profit & Loss a/c, Trading account and balance sheets of 2 subsequent dates.

Balance Sheet is prepared with the help of Trial balance.

Funds Flow Statement is prepared to identify how the profit has been utilized.

Balance Sheet is prepared to ascertain the financial position of the firm.

Funds Flow Statement provides additional information to the firm, regarding its functions for effective management.

Balance Sheet provides the static view of financial affairs.

For the preparation of Funds Flow Statement, schedule of changes in working capital and funds from the operation are to be prepared first.

Balance Sheet is prepared after the completion of Trading a/c and Profit & Loss a/c.


Differences between Funds Flow Statement and Income Statement:

Funds Flow Statement

Income Statement

Funds Flow Statement is a statement of significant changes in the assets, liabilities and capital accounts.

Income Statement is a summary of total income, total expenses and total losses of a year.

Funds Flow Statement is prepared to ascertain the sources and applications of funds.

Income Statement is prepared to ascertain the profit earned or losses suffered by the firm.

Funds Flow Statement is determined on the profit and loss a/c basis and balance sheet.

Income Statement is prepared on nominal accounts basis.

Funds Flow Statement helps to determine the net changes in working capital.

Income Statement helps to measure a firm’s profitability.

Funds Flow Statement deals with both revenue and net working capital.

Income Statement only deals with revenue items.

For the preparation of Funds Flow Statement, the income statement is required.

Income Statement does not require any reference to the funds flow statement to be prepared.

Funds Flow Statement is a firm’s optional statement which covers at least 2 years.

Income Statement is an essential statement of a firm which covers only 1 year period.


Differences between Funds from Operation and Net Profit:

Funds from Operation

Net profit

It is determined on the profit and loss a/c basis and balance sheet.

Net profit is based on nominal accounts.

Funds from Operation exclude both non-operating expenses/ losses and non-operating incomes.

Net profit includes both operating and non-operating items, as it is the difference between total revenue and total expenses and losses.

Funds from the operation are unrelated with non-cash items.

While calculating net profit, both cash and non-cash expenses are deducted.

It represents the flow of working capital from the operating activities.

Net profit represents a business’s operating result.

Funds from operation help in analyzing the operation position of a business.

Net profit helps in determining the tax amount.


Limitations of Funds Flow Statement

Funds Flow Statement might be a major financial analysis tool; however, it does have its limitations. Some of the examples are presented below:

  • Funds flow statement is a re-arranged data from a balance sheet and income statement and thus, lacks originality.
  • Funds flow statement ignores the non-fund transactions. Such as, purchase of fixed assets by issuing shares or debentures.
  • It indicates only the past position in summary form and does not show various continuous changes taking place.
  • Funds flow statement only shows the flow of net working capital, which includes items like prepaid expenses and stock of goods while not contributing to the short-term ability of the firm to pay its debts.
  • Because of its historic nature, funds flow statement is not an ideal tool for financial analysis.

References:

Koirala, Madhav et.al., Principles of Accounting -XII, Buddha Prakashan, Kathmandu

Shrestha, Dasharatha et.al., Accountancy -XII, M.K. Prakashan, Kathmandu

Bajracharya, Puskar, Principle of Accounting-XII, Asia Publication Pvt. Ltd., Kathmandu

  1.  When a transaction affects fixed assets and fixed liabilities or current assets and current liabilities, the flow of funds does not occur.
  2. Funds flow statement is a re-arranged data from balance sheet and income statement and thus,lacks originality.
  3. The term ‘Flow of Fund’ refers to the changes in working capital or the movement or changes of funds.
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