FUNDS FLOW STATEMENT

Balance Sheet

Before understanding the meaning of flow in funds, it is necessary to classify the balance sheet of a concern into four parts as shown below:

Important Note: Though provision for tax & proposed dividends are a part of Current Liabilities & Provisions, still while preparing Schedule of Changes in Working Capital, these items shall be ignored & these items shall be shown separately in Funds Flow Statement due to the reason that these expenses are important expenses & flow of funds towards items needs special attention. Hence if some examination problems do provide that these items be treated as non liabilities, should be interpreted in a logical sense.

The terms used in the above balance sheet are explained below:

1. Non-Current Liabilities: These Liabilities are not payable within a year and out of Current Asses These Liabilities are generally payable either in the long period or at the close of the business. For example, see item in the above Balance Sheet.
2. Current Liabilities: These Liabilities are payable within a year and out of Current Assets. The values of these Liabilities change within one year. Long-Term Liabilities if matured and are to be paid in the current period out of current assets, will become Current Liabilities. For example, see item (2) in the above Sheet.
3. Non-Current Assets: These Assets are obtained in business for use over a long period of time for earning purpose. These Assets are not purchased for the purpose of selling and include tangible, intangible and fictitious assets. For example, see item (3) in the above Balance Sheet.
4. Current Assets: These Assets are equal to cash or reasonably expected to be realised in cash or sold or consumed within one year or during the normal operating cycle of the business. For example, see item (4) in the above Balance Sheet.

Meaning of Flow of Funds:

The word 'Funds' means Working Capital, the word 'Flow' means Change- hence -flow in- funds means change working capital.

Out of all transactions, we have to see which transactions bring flow in funds and other transactions which do not affect the flow of funds.

(A)       Transactions that will affect the Flow of Funds:

1. Current Assets and Non-Current Assets: Whenever in any transaction one aspect affects the Current Assets and the other Non-Current Assets, there is flow in the Working capital. For example, when a Building is purchased for cash, Non-Current Assets will increase and Current Assets will reduce without any corresponding change in Current Liabilities. So working capital will decrease. Similarly, if any fixed asset is sold, there is increase in Current Assets (without corresponding change in current liabilities) and reduction in non-current assets; so it will increase the working capital.
2. Current Assets and Non-Current Liabilities: If in any transaction, one aspect affects the Current Assets and the other Non-Current Liabilities, there will be flow in the working capital. For example, if Equity shares are issued for cash, it will increase the cash (current assets) without any corresponding increase in current liabilities and also increase the equity share capital (non-current liabilities), there is increase in working capital. On the other hand, if Long Term Liabilities i.e., debentures are paid in cost, it will decrease the Current Assets and decrease the Non-Current Liabilities without any change in Current Liabilities so it will reduce the working capital.
3. Current Liabilities and Non-Current Liabilities: If in any transaction, one aspect affects the Current Liabilities and the other Non-Current Liabilities, there will be flow in the working capital. For example, if debentures are issued to the creditors it will increase the Non-Current Liabilities and decrease the Current Liabilities without any change in Current Assets; so there will be increase in the working capital.
4. Current Liabilities and Non-Current Assets: If in any transaction, one aspect affects the Current Liabilities and the other Non-Current Assets, there is flow in the working capital. For example, if building is purchased on credit, it will increase the Non-Current Assets and also Current Liabilities (without any change in Current Assets): so there will be decrease in the working capital.

In short, it can be said that when one aspect is of non-current category, and the other of current category, there will De flow in funds.

(B)       Transactions that will not affect the Flow of Funds:

The following transactions will not bring any change in the working capital and thus, there will be no flow in funds.

1. Current Assets and Current Liabilities: When in any transaction one aspect affects the Current Assets and other Current Liabilities, there is no flow in funds. For example, if goods are sold on credit, it will increase the debtors (current assets) and will reduce the stock of goods. So there will be no change in the working capital. Similarly, if cash is paid to creditors, it will decrease the Current Assets and decrease the Current Liabilities, there will be no change in the working capital.
2. Non-Current Assets and Non-Current Liabilities: If in any transaction, one aspect affects the Non-Current Assets and the other Non-Current Liabilities, there will not be any change in the working capital. For example, if building is purchased by the issue of Equity Shares, it will increase the Non-Current Assets and non-current liabilities, but there will not be any change in working capital. Similarly, if Debentures are redeemed out of the amount received from the sale of machinery, it will reduce the Non-Current Assets and Non-Current Liabilities. But there will be no change in working capital.
3. Non-Current Liabilities and Non-current Assets: If there is any transaction both aspects of which affect Non-Current Liabilities (or Non-Current Assets), it will not affect the working capital. For example, if Debentures arc converted into Share Capital it will on one hand increase the Non-Current Liabilities and on the other hand decrease the Non-Current Liabilities.

Conclusion:

1. When both aspects of a transaction belong to non-current category (either Non-Current' Assets or Non-Current Liabilities or one aspect is Non-Current Asset and the other Non-Current Liability) or are of current category i.e., Current Assets or Current Liabilities or when one aspect is a Current Asset and the other Current Liability or only of Non-Current Liabilities, then such transactions will not bring flow in funds.
2. When out of both aspects of a transaction one aspect belongs to Non-Current category and the other Current category i.e., one aspect is Current Asset or Liability and the other Non-Current Asset or Non-Current Liability, this will bring the flow in funds.

Schedule of Changes in Working Capital:

This Statement is prepared from Current Assets and Current Liabilities in order to calculate the increase or decrease in working capital. The following rules may be applied to Current Assets and Current Liabilities for preparing this statement:

(i)         An increase in Current Assets increases working capital:

(ii)        A decrease in Current Assets decreases working capital;

(iii)       An increase in Current Liabilities decreases working capital; and

(iv)       A decrease in Current Liabilities increases working capital.

Funds Flow Statement:

The Funds Flow Statement is a financial statement which reveals the methods by which the business has been financed and how it has used its funds between the opening and closing balance sheet dates. The funds flow statement describes the sources from which additional funds were derived and the uses to which these funds were put. The analysis of such statements over periods of time clearly shows the sources from which past activities have been financed and brings to highlight the uses to which such funds have been put. The statement is known by various titles, such as, Statement of Sources and Applications of Funds, where Got and Gone Statement and Statement of Resources Provided and Applied.

The items of sources and applications are given as follows:

Sources of Funds

The following are the sources from which funds come:

(i)         Funds from Operations.

(ii)        Income from Investments (Interest, Rent, Dividend received).

(iii)       Issue of Shares and Debentures,

(iv)       Raising of Loan.

(v)        Sale of Fixed Assets and Long-Term Investments,

(vi)       Receipt of Refund of Tax

(vii)      Introduction of Capital in case of proprietary or partnership business

(viii)     Decrease in working capital etc.

Uses (or Applications) of Funds

The following are the various purposes -for which funds can be used.

(i)         Funds Lost in Operations.

(ii)        Repayment of Long-Term Loans.

(iii)       Redemption of Preference Shares and Debentures.

(iv)       Purchase of Fixed Assets.

(v)        Purchase of Long-Term Investments.

(vi)       Payment of Cash Dividends,

(vii)      Payment of Taxes,

(viii)     Drawings in case of Proprietary or Partnership Business.

(ix)       Increase in Working Capital, etc.

Objectives of Funds Flow Statement:

Generally a business prepares two financial statements i.e., position statement or balance sheet and income or profit and loss account. The former reflects the state of assets and liabilities of a company on a particular date whereas the latter tells about the result of operations of the company over a period of a year. These financial statements have great utility but they do not reveal the movement of funds during the year and their consequent effect on its financial position. For example, a company which has reportedly made substantial profits during the year may discover to its surprise that there are not enough liquid funds to pay dividend and income tax because of profits tied up in other assets, and is always after the bank authorities to get the cash credit or bank overdraft facility. In order to remove this defect, another statement known as funds flow statement is prepared.

Thus, the main purposes of such statement are:

(i)         To help to understand the changes in assets and asset sources which are not readily evident in the income statement or the financial position statement.

(ii)        To inform as to how the loans to the business have been used, and

(iii)       To joint out the financial strengths and weaknesses of the business.

Calculation of Funds from Operations:

There are two methods of calculating the Funds drom Operations:

1. By starting with the net profit already calculated, add non-operating expenses (i.e. not relating to the business), such as trade marks, preliminary expenses, patents, goodwill, loss on sale of assets, provision or reserve for any asset or expenses, proposed dividends, non-cash items as depreciation and deduct those incomes which are not relating to business (i.e. non-operating income) such as profit on the sale of an asset, dividend received, refund of tax etc
2. By preparing Adjusted Profit and Loss Account showing income only relating to the business and expenses which are paid and relating to the business. The residual figure will be funds from operations. Non-cash items like depreciation and non-operating expenses like trade marks, preliminary expenses, patents, goodwill, loss on the sale of assets, proposed dividend, provisions and reserves for any asset are debited. Similarly, non-operating income like profit on the sale of any asset, dividend received, or any other income not relating to the business is credited while calculating funds from operations.

A specimen is given as follows:

Adjusted Profit and Loss Account