Fund Flow Statement | Meaning and Introduction | Rule of Working capital | Profit From Operations
A funds flow statement is a statement that comprises the inflows and outflows of funds. It includes the sources of funds and application of funds for the particular period. Therefore, you can analyse the reasons behind the change in a company’s financial position. This article explains the funds flow statement, its components, importance and limitations.
A funds flow statement explains the changes in a company’s working capital. It considers the inflows and outflow of funds (source of funds and application of funds) for a particular period. The statement helps in analysing the changes in a company’s financial position between two balance sheet periods.
The statement helps in determining how the funds are being used. As a result, analysts can assess the company’s fund flow in the future.
Components of a Fund Flow Statement
The statement comprises the following 2 components:
Sources of Funds: Includes where the funds have come from and their source.
Application of Funds: Denotes the usage of funds for short term and long-term needs.
Fund inflows can be through issues of shares or debentures or from the sale of fixed assets. Or through business operations.
How to Prepare Fund Flow Statement?
To prepare a funds flow statement, you have to follow the below steps:
Step 1
Prepare a Schedule of Changes in Working Capital. Consider the increase or decrease in the current assets and current liabilities. The difference between the net current assets and net current liabilities gives the net increase or decrease in working capital.
Increase in Working Capital
When the long-term source of funds is more than the application or use of funds, it is referred to as an increase in working capital. Since a company can use these funds for their working capital needs. For instance, payment of short-term loans or dividends can be paid. As a result, an increase in working capital will become part of the ‘Application of Funds’ in the Funds Flow Statement.
Decrease in Working Capital
A company may require more funds but has only a limited long term source of funds. In such scenarios, the company will use the funds available for working capital. As a result, funds available for working capital are reduced. Thus, a decrease in working capital will become part of the ‘Source of Funds’ in the Funds Flow Statement.
Step 2
Prepare the Adjusted P&L Account to find out Funds from Operations. It includes the funds used and generated from operating activities of the business and not from investing and financing activities. Here some adjustments that the company makes to the net profit for the year. They add back non-cash expenses like depreciation and amortisation. They subtract any profit from the sale of investments and fixed assets to arrive at the actual fund generated from operating activities.
Step 3
To create the fund flow statement; you need to identify the Sources of Funds (Inflows) and Application of Funds (Outflows). Identify the source of funds or application of funds (increasing or decreasing) from the balance sheet to create a fund flow statement. And also net increase or decrease in working capital and funds from operations to complete the statement.
Sources of Funds
The line items under sources of funds include:
Issue of shares and debentures: Only the issue of shares or debentures come under this head. Any bonus issue of convertible debentures do not come here as there is no cash inflow.
Long-term loans: Only long-term loans and borrowings come under this section. This is because the short-term loans are already present in the working capital statement.
Sale of fixed assets: The amount received from the buyer of the fixed assets.
Funds from operations: It is the funds from the operating activities of the business . It is computed in the previous step in the statement showing funds from operations.
Decrease in working capital: This is basically the balancing figure of the fund flow statement and will match the amount in the change in the working capital statement.
Application of Funds
The line items under application of funds include:
Purchase of fixed assets and investments: Only cash payments made for purchasing assets and investments have to be recorded. Also, purchases made in exchange for shares or debentures should not be recorded as there is no cash outflow.
Redemption of debentures and repayment of loans: Payment made against debentures or loans, including premium and excluding discount, must be considered as the application of funds.
Payment of dividends and tax: Payment of dividends and tax is the application of funds. However, the provisions are excluded from current liabilities and added back to determine funds from operations.
Increase in working capital: This is basically the balancing figure of the fund flow statement and will match with the amount in a change in the working capital statement.
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