What is Fund flow statement?

What is Fund flow statement?

Fund flow statement
Introduction
Traditionally, balance sheet and income statement (profit and loss account) were the major component of financial statement. Balance sheet and income statement reveal the result of business operation and the position of assets, liabilities and capital. The balance sheet shows all the assets owned by a concern and all the liabilities and claims it owners and outsiders. Likewise, income statement is prepared to determine the operational result i.e. profit earned or loss incurred by an organization during a particular year.

However, balance sheet control cannot explain the changes in assets, liabilities and capital accounts. In other words, the balance sheet gives a static view of the resources of a concern and the uses to which these resources have been applied at a certain point of time. However, balance sheet fails to deter the causes for the changes in assets, liabilities and equity between two subsequent balance sheet dates. Similarly, profit and loss account disclosed the profit or loss suffered by the concern during a particular year. But it cannot indicate the impact of profit or loss on cash and liabilities position of the firm. Sometimes a concern may have higher profit but the concern may still be unable to meet its liabilities.

Over time, another financial statement named statement of charges in financial position is emerged to remove the limitation of balance sheet and income statement. The compete set of modern financial statement must included balance sheet, income statement and the statement of changes in financial position. These statements are presented in the following figures:

The statement of changes in financial positions is a statement of flow of resources of concern. The statements of changes in financial position measure the changes that have taken place in the financial position of a concern between two balance sheet dates. The statement of changes in financial position measure the changes that have taken place in the financial of  a concern between two balance sheet date summaries the sources from which funds have been obtained and the uses to which they have been utilized.

The term 'fund' is related with two concepts i.e. working capital and cash. According to working capital concept, the term 'fund' represents the difference of current assets and current liabilities. Accounting to cash concept, the term 'fund' indicators the changes in cash balance. Based on these two concepts of fund, the statement of changes in financial positions is prepared either on working capital basis or on the basis of cash. The statement base on working capital is known as fund flow statement and the statement prepared on the basis of cash is called flow statement.

In this way, the balance sheet and income statement are the traditional basis financial statement of a concern. They furnish useful financial information regarding the operation of the concern, however, a serious limitations of these statements is that they fail to provide information regarding hangs in the financial position of a convert during a particular period of time. The statement of changes in financial position overcomes these limitations of traditional financial statements.

Meaning of fund flow statement
Found flow statement s the statement of source and use of found. Funds flow statement shows the sources from which the funds are received and the areas to which they obtained funds have been utilized. Funds flow statement indicates various mean by which funds were received during a particular period and the ways in which these funds were applied.

Funds flow statement comprises three words- fund, flow and statement. 'Fund' means the financial resources used by a concern. In the sense of working capital, 'fund' represents the next working capital the excess of current assets over the current liabilities is called net working capital. Similarly, the term 'flow' means the movement of funds and included both inflows (receipts) and outflow (payment) of fund. Funds from operations, issue of share and debentures, additional long-term debts, non operating revenue, repayment of long term loan, payment for non operating expenses etc. are the main areas of uses of fund. The term 'statement' represents the format or amount under which the flows of fund flow format or account under which the flows of fund i.e. statement of sources and applications of funds, statement of changes of financial positions, statement of sources and uses of funds, summary of financial operations, where get and where. Gone statement, movement of working capital statement. Funds received and disbursement statement etc.

Thus, funs flow statement is an essential tool for financial analysis. It explains the sources from which additional fund i.e. working has been arrived and the uses to which the fund or working capital has been employed. Fund flow statements are prepared on the basis of two balance sheets of subsequent dates and highlight the changes in the financial position of a concern.

Objective and importance of fund flow statement
The main objectives of fund flow statement are as below:
To explain the changes in financial position: the objective of funds flow statement is to disclose the cause of change in the assets, liabilities and equity capital between two balance sheet dates. It highlights the changes in financial position of a concern and indicates the various means by which funds were obtained during a particular period and the ways to where these funds were utilized.

To analytic the operational position: another objective of funds flow statement is to analyze the operational position of a concern. Balance sheet gives a static view of the financial position and the profit and loss reports by income statement cannot tell about the actual liquidity position of a firm. Sometimes a firm with high profit may be able its immediate liabilities due to the shortage of cash. But objective funds flow statement is to both the causes of various in difference assets liabilities and capital accounts and their effect on the liquidity position of the concern.

To help in proper allocation of resources: the objective of fund flow statement is to provide information regarding the allocation of limitation regarding the allocation of limited resources with more efficiency and effectively. It provides date regarding the unbalanced fund. On the basis of such information a concern can allocate it funds in short term and long term areas more properly.

To evaluate financial position: internal and external users of financial statement required funds flow statement for the purpose of assessing the strengths and weakness of the concerned firm. Funds flows statement provides information regarding the changes in net assets of a firm, its financial structure, liquidity position and ability to generate fund, these information enable various groups of users to assess and evaluate the financial position of the firm.
To act as future guide: funds flow statement acts as a guide for future to management. Funds flow statement provides information about the historical changes inept assets and capital which enables the management to develop a projected funds flow statement. Such projected funds flow statement helps to predict the future for fund and alternative sources of financing.

Preparation of funds flow statement
Funds flow statements is prepared on the basis of balance sheet of two subsequent dates information such as net profit or loss reported by incomes statements, operating and non operating expenses, and gains etc. to procedures of preparing funds flow statement consist of the following three steps:
•    Determination of net changes in working capital (WC)
•    Determination of funds from operation (FFO)
•    Preparation of funds flow statement (FFS)
   
Net working capital is related with current assets and current liabilities. Funded from operation is determined with the help of net income or loss, non-operating and non-cash items. Similarly, funds flow statement is prepared from the differences of non-current assets, non-current liabilities and non-operating items.

Step I: preparation of statement of changes in working capital
The difference current assets and current liabilities is called net working capital. In other words working capital is the excess of current assets over the current liabilities. Current assets are words; working capital is the excess o current assets over the current liabilities. Current assets are these assets which can be covered into cash within short time period (generally one year) without any adverse effect in their value. The example of current assets are cash in other, bank balance prepared expense accrued income, bills receivable, marketable securities, debtors, short-term investment, inventory/stock and other short term assets.

Similarly, current liabilities are those outsides obligation which must be repaid within short notice and include creditors, bills payable, advance incomes, bank overdraft, outstanding expenses short –term loan and other short-term liabilities.

On the basis of current assets and current liabilities reported on two balance sheets, the change in net working capital is determined short-term liabilities.

Net working capital = current assets – current liabilities

Step ii: determination of funds from operation
The amount of working capital provided by a business organization from its day business operation is called funds operations. The profit reported by the income statement (profit and loss account) does not indicate the actual working capital generations form the operation of business due to the following reasons:

•    Profit and loss account contain non-cash operating expenses such as depreciation which do not invoice any movement of funds.
•    Profit and loss account contains non-operating expense and losses such as amortization of intangible assets, loss and sales of fixed assets and investment etc., which do not involve any corresponding movement of fund.
•    Profit and loss account contains non-operating income and gains such dividend received, gain on sale of fixed assets and investment, premium on repayment of long term debt etc. which do not involve any corresponding movement of fund.
a.    Determination of funds from operation by using statement method
Under statement method, all the non cash expenses, non operation expenses and non operating losses are added to back with net profit for the purposes of determining funds from operation. Similarly, all the non operation revenues, income and gains are subtracted form net profit. It is important to note that all the items of profit and loss account which are paid in cash and related with the operation of the business are ignored while determining the funds from operation.
b.    Determination of fund from operation by adjusted profit and account
Under this method, an adjustment profit and loss account is prepared by debating all the non cash expenses, non operation expenses and non-operating together with net profit. Similarly, all the non operation revenues, income and gains are credited to an adjusted profit and loss account. Like statement method, all the items of profit and loss account which are paid in cash and related with the operation of the business are ignored while determining the funds from operation under adjusted profit and loss account method too.
c.    Determination of funds from operation under direct method
This method is just reverse to above two methods. Under this direct method. All the expense which are required for the operation of business and are and paid in cash are subtracted from the operating revenue whereas all the non cash expenses, non operating expenses, non operation income and gains are ignored.

Step iii: preparation of funds flow statement
Funds flow statement is a statement, which depict different sources from which funds have been obtained during a certain period and the applications to which these funds have been spent. Following points are considerable for the reparation of funds flow statement.
a.    Identify the changes in non-current assets accounts
For the purpose of preparing funds flow statement, non-current assets and non-current liabilities are taken into consideration. It is because current assets and current liabilities are shown in statement of changes in working capital.
b.    Identify the changes in non-current liabilities accounts 

c.    Consider the transaction which result "flow of fund".
The flow of fund occurs only when a transaction changes on the one hand a non current (fixed asset or fixed liability) account and on the other hand a current account (current assets or current liability. In other words, the flow of fund occurs when a transaction affects:
•    Current assets and fixed assets e.g. sloe of fixed assets on cash, or credit.
•    Current liabilities and fixed assets e.g. purchase of fixed assets on credit.
•    Current assets and fixed liabilities e.g. purchase of inventory by the issue of share or debentures, or
•    Fixed liabilities and current liabilities e.g. payment ton editors by the issue of debentures etc.
Some items which generate the flow of funds are listed as below:

d.    Do not consider the transaction which result "no flow of fund"
The flow of fund does not occur when a transaction affected fixed assets and fixed liabilities or current assets and current liabilities. Purchase of inventory on cash or credit, sales of inventory on cash or credit, payment to creditors, collection form debtors, sales or purchase of marketable securities, exchange of fixed assets, redemption of debentures by the issue of share, purchase of fixed assets by the issue of share, conversion of debenture into shares of some transaction which do not affect the flow of funds and not recorded in the funds flow statement.

e.    Prepared funds flow statement by using horizontal or vertical format
The fund flow statement can be prepared either by using horizontal format or by using vertical format.
Horizontal format: horizontal form of funds flow statement is prepared by showing sources of funds in the hand side and uses of funds in the right hand side.
Vertical format: under this form of fund flow statement, sources of funds are shown on the upside of the statement and uses of fund (except working capital) are shown just below to sources of funds.

 Difference between balance sheet and fund flow statement
The main difference between balance sheet and funds flow statement are as below:

Difference between income statement and fund flow statement
Income statement and funds flow statement can be distinguished as below:

Difference between net profit and funds from operation
Following are the difference between net profit and funds from operation:

Limitations of funds flow statement
Funds flow statement is a major tool of financial analysis, however, it as the following limitations:
Ignores the non-fund transaction: fund flow statements ignore the non-fund transaction i.e. it does not take into consideration those transaction which do not after the working capital. For example, funds flow statement does not record the purchase of fixed assets by the issue of share or debentures.

Bases on secondary information: fund flow statement is based on secondary date. In other words, funds flow statement is based on income statement and balance sheet.
Historical in nature: funds flow statement is historical in nature because it is prepared on the basis of historical function statement i.e. balance sheet and income statement.
Adjustments
To identify whether is an inflow or outflow of funds an account of non-current items, the account of all non-current items should be prepared after taking into considered the following.
i.    Opening balance (given in opening balance sheet)
ii.    Closing balance (given in closing sheet)
iii.    Relevant additional information (if any given)

Some importance adjustments required for the preparation of funds flow statement are as below:
•    Purchase and sales of fixed assets
•    Depreciation on fixed assets
•    Profit and loss on sales of fixed assets
•    Intangible assets written off
•    Fictitious losses written off
•    Provision for dividend
•    Interim dividend
•    Stock dividend
•    Premium on issue of shares
•    Premium on issue of debentures
•    Premium on redemption of debentures
•    Discount on issue of debenture
•    Purchase of assets by the issue of shares

1.    Adjustment related to trading fixed assets
Tangible fixed assets accounts are prepared as below:
•    Start entering the operating balance in the side.
•    Enter the closing balance in the debit side
•    If the amount of debit side is less than the amount of credit side, te balancing figure repress the purchase of assets.
•    If the amount of credit side is less than the amount of debit side, the balance figure represents the either sales of assets or depreciation on fixed assets.
Purchase and sales of fixed assets on cash: fixed assets account on which no depreciation has been charged is prepared as below:
i.    Opening balance sheet of fixed assets is debited and closing balance is crepitated.
ii.    The balance figure of credit side represents the sales of fixed assets during the year and is treated as sources of funds. In the absences of any information, the cost price of assets is assumed as the sales of assets.
iii.    The debit balance represents the purchase of fixed assets during the year and is treated as uses of fund. In the absences of any information, the increase in the cost price of assets is assumed as purchase made during the year.
iv.    The loss on sales is transferred to adjusted profit and loss account and is appears in the credit side of assets account. I there is gain on the sale of assets, it will appear in the debit side of assets account. In the absence of any information, it is assumed that there is no profit or loss and no accumulated depreciation on the part of assets which has been sold.

Depreciation on fixed assets: depreciation is the gradual decrease in the value of fixed assets due to their continuous and permanent use. Depreciation is treated as an expense and debited in the profit & loss account. Depreciation is a non-cash charge that represents a reduction in the value of fixed assets due to wear, age or obsolescence as well as a source of fund. The effect of depreciation is shown in the balance sheet in the following ways:
i.    Net cost method: under net cost method, assets are recorded at book value or net cost i.e. depreciation is deducted from the cost of assets in the assets side of balance sheet. Under this method a separate depreciation account is not shown in the balance sheet. The depreciation charged during the year is debited in the profit and loss account. While preparing funds flow statement, the depreciation charged on fixed assets is credited to related assets account and debited in the depreciation charge on fixed assets is credited to related assets account and debited in the adjusted profit and loss account.
Calculation of purchase of fixed assets = opening balance, net + purchase- depreciation for the year – book value of sold part= closing balance, net
ii.    Gross cost method: under gross cost method, assets are recorded at original cost and accumulated depreciation is not deducted from the cost of asset. Under this method, a separate depreciation account appears either in the liabilities side of balance sheet or in the assets side in the form of deduction.

Purchase of assets by the issue of shares or debentures: sometimes companies issue shares or debentures to purchase current and non-current assets. There is no flow of fund if non-current assets are purchase by the issue of non-current liabilities such as shares and debentures. However, there is flow of funds if current assets are purchase through fixed liabilities such as by the issue of share or debentures.

2.    Adjustments related to intangible assets
Goodwill, patent, copyright and trademarks are the example of intangible assets. In the absence of any information, the increase in intangible assets is treated as the purchase and decrease in these assets is considered as written off. The increased value of intangible assets is recorded as use of fund and written off value is debited into adjustment profit and loss account.

•    Start entering the opening balance in the debit side.
•    Enter the closing balance in the credit side.
•    If the amount of debit side is less than the amount of credit side, the balance figure represents the purchase, in the absence of any information.
•    If the amount of credit side is less than the amount of debit side, the balancing figure of credit side represents written off or amortization of intangible assets which is transfer to profit and loss account.
3.    Adjustment related to miscellaneous expenditures
Discount on issue of shares and debenture, underwriting commission, preliminary expenses, advertisement development account etc. are the example of miscellaneous expenditure and losses, such account are prepared as below:
•    Start entering the opening balance in the debit side.
•    Enter the closing balance in the credit side.
•    Generally, there is no debit balance of fictitious assets account. If the amount of credit side is less than the amount of debit side, the balancing figures of credit side represents written off or abortion of fixation assets which is transfer to profit and loss account.

Decrease in miscellaneous expenses: any decrease in miscellaneous expenses account is considered as written off. Like intangible assets, the written off value of miscellaneous account is debited into profit and loss account.

Increase in value of miscellaneous expenses: generally, the value of miscellaneous expenses do not increase, however, in special case, the value may increase and the increased value is debited to respective miscellaneous expense account and credited to the account to the account due to which miscellaneous expenses are increased. In the absence of any information, the increased value is considered as payment and recorded in the uses side of fund flow statement.

4.    Adjustment related to non-current liabilities accounts
Non-current liabilities accounts are prepared as below:
•    Enter the opening balance in the credit side
•    Enter the opening balance in the debit side.
•    In case of share capital, share premium, debentures and other long-term debt, the balancing figure of credit side represent sources of fund i.e. issue of shares/ debentures, additional loan received, etc. the balancing debit side represents the redemption of debentures or payment of loan etc. in case of prevision, the difference is generally transferred to profit and loss account in the absence of information.

Adjustments related to ordinary and preference shares: share capital is an on-current liability. The increase in the both types of share capital account is an indication of additional issue of shares capital and is regarded as sources of funds. Shares are issued on the following conditions:
i.    Issue of shares at par: if share are issued at par, the net increase in the share capital account is traded as the as source of fund.
ii.    Issue of share at premium: if share are issued at premium, the actual amount received would be more than the net increase in share capital account. In the case of premium, the source of funds included increase in par value of share plus increase in share premium account.
iii.    Issue of share at discount: in case of discount, the source of fund includes increase in par value of shares minus increase in discount on issue of share account.

5.    Adjustment related to prevision of taxation
Prevision for taxation is treated as below:
a.    Current liability: in the absence of any information, prevision for taxation is treated as current liability and included in the statement of changes in working capital.
b.    Non-current liability: prevision of taxation may be treated as non-current liability. In such condition, the actual amount paid Is recorded as the use of fund and the balance is treated as prevision made during the year which is debited into adjusted profit and loss account.
6.    Adjusted related to dividend
Provision for dividend: like provision for taxation, provision for dividend is treated as below:
i.    Current liability: in the absence of any information, prevision for dividend is treated as current liability and included in the statement of charges is working capital.
ii.    Non-current liability: generally, prevision for dividend is treated as non-current liability. In such condition, the actual amount paid is recorded as the use of fund and the balance is treated as prevision made during the year.

Stock dividend: sometimes companies distribute additional shares to shareholder as dividend. Such dividend is called stock dividend or bonus shares. The balance of undistributed profit decrease and share capital increase due the stock dividend. However, cash balance is unaffected by the stock dividend. Therefore, stock dividend is not treated as use of fund and not shown in the funds flow statement. Te effect of stock dividend on different account is as below:
i.    First method: under this method, retained earning account is prepared to determine the amount of net profit or dividend which is not given. Thereafter, adjusted profit and loss is prepared to determine the funds from operation.
ii.    Second method: under this method, stock dividend is shown in the debit side of adjustment profit and loss account.