The profit and loss account and balance sheet statements are the common important accounting statements of a business organization. The profit and loss account provides financial information relating to only a limited range of financial transactions entered into during an accounting period and its impact on the profits to be reported.
The word ‘fund‘ refers to a sum of money, which is used to finance the firm’s day to day operations and acquire assets for the business. The flow of funds represents the movement of funds, i.e. the change in economic resources, from one asset or liability to another. In this way, the fund flow statement implies a method of analysing the changes in the firm’s financial position, between two balance sheet dates.
The balance sheet contains information relating to capital or debt raised or assets purchased. But both the above two statements do not contain sufficiently wide range of information to make assessment of organization by the end user of the information.
The excess of current assets over current liabilities is called ‘working capital’. The excess of funds generated over funds outgo from non-current assets and non-current liabilities will lead to increase or decrease in working capital.
Fund flow statement is useful in knowing the changes in the structure of assets, liabilities and capital. It shows whether the sources of funds coincides with its application and indicates the accuracy of a firm’s financing and investment decisions. Unlike the cash flow statement, which is prepared on a cash basis, the fund flow statement is prepared on an accrual basis.
This can further be analyzed into increase or decrease in respective current assets and current liabilities. 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 of the ‘fund’ is ‘working capital’. Working Capital is the excess of current assets over current liabilities.
In funds flow analysis, we shall also abide by the popular definition of funds, meaning working capital. The ‘flow’ of funds refer to transfer of economic values from one asset equity to another. When ‘fund ‘mean working capital, flow of funds refers to movement of funds which cause a change in working capital of the organization.
Identification of Flow of Funds:
A ‘flow’ of funds takes place only if a current account is involved. To identify a flow, journalize the transaction, identify the two accounts involved as ‘current’ and ‘non-current’ and apply the general rule.
(a) Transactions which involve only current accounts do not result in a flow.
(b) Transactions which involve only non-current accounts do not result in a flow.
(c) Transactions which involve one current account and one non-current account results in a flow of funds.
Sources of Funds:
The funds inflow into the organization will come from the following sources:
Funds Generated from Operations During the course of trading activity, a company generates revenue mainly in the form of sale proceeds and paid out for costs. The difference between these two items will be the amount of funds generated by the trading operations.
Steps for Preparing Funds Flow Statement:
The steps involved in preparing the statement are as follows:
- Determine the change (increase or decrease) in working capital.
- Determine the adjustments account to be made to net income.
- For each non-current account on the balance sheet, establish the increase or decrease in that account. Analyze the change to decide whether it is a source (increase) or use (decrease) of working capital.
- Be sure the total of all sources including those from operations minus the total of all uses equals the change found in working capital in Step 1.
General Rules for Preparing Funds Flow Statement:
The following general rules should be observed while preparing funds flow statement:
- Increase in a current asset means increase (plus) in working capital.
- Decrease in a current asset means decrease (minus) in working capital.
- Increase in a current liability means decrease (minus) in working capital.
- Decrease in a current liability means increase (plus) in working capital.
- Increase in current asset and increase in current liability does not affect working capital.
- Decrease in current asset and decrease in current liability does not affect working capital.
- Changes in fixed (non-current) assets and fixed (non-current) liabilities affects working capital.
Format of Funds Flow Statement:
A funds flow statement can be prepared in statement form or ‘T’ form.
Both the formats are given below:
Schedule of Changes in Working Capital:
Many business enterprises prefer to prepare another statement, known as schedule of changes in working capital, while preparing a funds flow statement, on a working capital basis. This schedule of changes in working capital provides information concerning the changes in each individual current assets and current liabilities accounts (items).