(on working capital basis)
In the words of 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 business during the accounting period.’ Thus, funds flow statement is a report of financial operation of a business undertaking. It clearly indicates from what sources the finance has been arranged in the business and how it has been used.
objectives of funds flow statement
The basic objective of funds flow statement is to indicate the sources from which the funds (i.e. working capital) were obtained and the specific uses to which such funds were applied between the dates of two balances sheets.
Funds flow statement and balance sheet can be distinguished as under :
The distinction
Funds flow statement is to know the temporary changes whereas balance sheet is an yearly affair throughout the life of business.
In funds flow statement only those accounts are shown which affect working capital whereas balance sheet contains the balance of ledger accounts.
The need of preparing funds flow statement arises due the fact that there are certain basic questions which cannot be answered by the balance sheet whereas balance sheet is prepared to ascertain the exact financial position of a business concern on a certain date.
There is no legal obligation to prepare funds flow statement. But Schedule VI to the Companies Act requires every company to prepare a balance sheet.
Headings used in funds flow statements are sources of funds and Application of Funds whereas the headings used in horizontal balance sheet are assets and liabilities.
Funds flow statement is not required to be prepared in prescribed form whereas company’s balance sheet is required to be prepared in a prescribed form.
Funds flow statement is prepared with the help of two consecutive balance sheets and additional information. Whereas balance sheet is prepared with the help of ledger balance and additional information.
In funds flow statement, all earnings are treated as sources of funds whereas in balance sheet only retained earnings are treated as sources of funds.
Meaning of Fund
The word ‘fund’ is used in a wider sense here. ‘Fund’ means working capital in this context, whereas working capital is equal to current assets less current liabilites.
Current Assets are those assets which are used within a year. Thus current assets include cash in hand, cash at banks, debtors, stock, bills receivable, temporary investments, stores and prepaid expenses.
Current Liabilities : These are the liabilities which are paid up within one year out of current assets.
Meaning of Funds Flow : The term flow of funds means changes in working capital. In other words, any increase or decreases in working capital in sourcess or application of funds flow.
transactions which affect working capital
Current Assets and Fixed Assets : If a transaction involves one aspect of current assets and the other aspect of fixed assets, it becomes a source of funds e.g. purchases of land, buildings, machinery etc.
Current Assets and Capital : If a transaction involves one aspect of capital and the other aspect of current assets, it affects the working capital.
Current Liabilities and Capital : When transactions involve one aspect of current liability and the other aspect of capital, there is flow of funds e.g. issue of shares to the creditors.
Current Liabilities and Fixed Liabilities : Those transactions which affect current liabilities and fixed liabilities, such as issue of debentures to creditors cause flow of funds.
Current Liability and Fixed
Assets : If one aspect of a current liability and the other aspect of fixed assets make change in working capital, such as transfer of machinery to creditors, there is flow of funds.
Current Assets and Fixed Liabilities : When a long term loan is paid in cash, it affects working capital.
Transactions which do not Affect working capital
Following business transactions do not make any change in the working capital:
Fixed Assets and Capital : When fixed assets are purchased and shares are issued, there is no change in the working capital.
Current Assets and Current Liabilities : If a transaction affects current assets on one hand and current liabilities on the other hand, there is no change in working capital, e.g. cash payment of bills payable.
Fixed Assets and Fixed Liabilities : If any fixed assets are affected on the one hand and fixed liabilities on the other hand, it had no impact on working capital e.g. purchases of machinery against debentures.
The performa given on page 533-534 shows which transaction have impact on working capital.
Schedule of changes in working capital
The under-mentioned rules should be followed to prepare change in working capital :
1. An increase in current assets increases working capital.
2. A decrease in current liabilities increases working capital.
3. An increase in current liabilities decreases working capital.
4. A decrease in current assets decreases working capital.
5. preparation of Funds flow statement
6. In order to prepare funds flow statement, one should know the sources of funds and their applications:
Sources of Funds in a business are as follows :
Funds from Operation: They include sales minus cost of goods sold.
Amortization of Non-funds Items : Amortization of fictitious assets does not affect the working capital. They should be added back to the net profit as trade mark, preliminary expenses, patent right, goodwill written off, advertisement, suspense account, discount on issue of shares and debentures and deferred expenses.
Depreciation : It does not affect the working capital. As such, it should be added back to the net profit.
Appropriation of Retained Earnings : They have no impact on working capital and should be added back to net profit as general reserves, dividend equalisation fund, reserve for contingencies and sinking fund.
Paid or proposed dividend should be added back to net profit.
Allowances for Income Tax Payable : These amounts should be added back to net profit.
Loss on Sale of Fixed Assets is not a trading loss and hence be added back to net profit.
Items to be deducted from net profit : These items include dividend received or receivable, profit on sale of fixed assets, appreciation of fixed assets, retransfer of excess provisions.
Calculation of funds from operation
Net Profit for the year
Add : Non-fund items and non-trading charges already debited to Profit & Loss Account, depreciation, preliminary expenses written off, goodwill, patents written off, discount on issue of debentures written off, premium on redemption of debentures written off, proposed dividend, transfer to general reserves, transfer to sinking fund, transfer to dividend equalisation fund, advertisement expenses written off, loss on sale of fixed assets.
Less : Dividend received or receivable, profit on sale of fixed assets, excess provision written back, provision for bad debts and appreciation in fixed assets.
