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Question 2. “Funds flow statement is only supplementary to


P/L Account and Balance Sheet, it can not substitute to P/L
Account and Balance Sheet”. Do you agree to this statement?
Explain your views.
Solution:

Funds flow statement is unique compared to other statement since it converts a stock statement
(balance sheet) into a flow statement. As such, there is not much of comparison or relationship
between funds flow and other financial statements. When compared to cash flow statements, funds
flow gives a broader view of financial flow. While cash flow shows how cash balance changed from
one period to another period, funds flow statement typically shows the changes in the balances of
working capital, which includes cash balance. Normally, funds flow statement is used to
understand long-term stability of business whereas cash flow statement is used to find out short-
term stability. Cash flow statement can be used to assess the quality of reported profit, whereas it
would be difficult to do such exercise with funds flow statement.

There are significant differences between funds flow statement and profit and loss account.
Though both of them are flow or period statement, profit and loss account excludes all capital-
related transactions like capital expenditure or capital receipts.

Funds flow statement considers both revenue and capital items. The only relationship between the
two statements is both are concerned with funds raised through operating activities. To get funds
from operating activities, we use profit and loss statement and perform some adjustments.

Fund flow statement is intended to explain the magnitude, direction and the causes of changes in
the position of funds (net working capital) that took place during the two balance sheets dates.
Thus, it highlights the basic changes in the financial structure, asset structure and the liquidity
position of a business between two balance sheet dates. But primarily, it reveals changes in the
financial position of the company by identifying the sources and application of funds resulting from
financing and investing decisions that took place during a particular period.

Funds flow statement is a kind of extension of Balance Sheet. There are number of similarities
between the two statements. Many accounting heads of both statements are common and the only
difference is the valuation. While Balance Sheet shows the figure as on a particular date, Funds
Flow Statement shows the period value. While Balance Sheets values are normally positive, funds
flow statement may show negative values on some of the items. For instance, consider secured
loan item of Balance Sheet. It might show a value of Rs. 200 lakhs last year and Rs. 150 lakhs at
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the end of current year. Both are positive values. In Funds Flow Statement, the secured loan
account will have negative value of Rs. 20 lakhs, since this much of amount is repaid and hence it
is application of funds. While Balance Sheet is a single statement, funds flow is normally prepared
in two stages and includes working capital statement.

Profit and Loss account is prepared to ascertain the net profit earned or net loss incurred by the
business concern during an accounting period. It starts with gross profit or gross loss as disclosed
by the Trading Account. It takes into account all the remaining direct (normal and abnormal)
expenses and losses related to or incidental to business. These operating and non-operating
expenses are charged to Profit and Loss Account and shown to the debit side of the Profit and
Loss Account. On the other hand Balance sheet is a statement of assets and liabilities which helps
us to ascertain the financial position of a concern on a particular date, i.e. on a date when financial
statements or final accounts are prepared or books of accounts are closed. In fact, it treats the
balances of all those ledger accounts standing to the debit or credit column of the Trial Balance
and which have not been squared up. These accounts relate to assets owned, expensed incurred
but not paid or not due, expenses due but not paid, incomes accrued but not received or certain
receipts which are not due or accrued. In fact it deals with all those “real” and “personal accounts”
which have not been accounted for in the Manufacturing, Trading and Profit and Loss Accounts.
Besides, the balance sheet also treats all those items in the adjustments, whch affect Real or
Personal Accounts. The Nominal Accounts are treated in the Income Statement (P&L A/c). A
Balance Sheet aims to ascertain nature and amount of different assets and liabilities so that the
financial position could clearly be known to all those concerned. Thus, the main function of the
Balance Sheet is to depict the true picture of the concern on a particular date. It is statutory
obligation of the company to prepare Balance sheet and statement of profit and loss as per
Schedule annexed to Companies Act 2013

Funds flow statement is not required under the current Accounting Standards and hence very few
companies provide such statement. Further, funds flow statement is not free from window dressing
since uses only the two principal financial statements. Many organisations prepare funds flow
statement for internal purpose and normally it is compared with budgets to set right deviation from
budgets

However An important contribution of funds flow statement is to know how funds have moved
between long-term and short-term needs of the organisation. It is generally believed that
organisation needs to match assets and liabilities on time scale though assets are always equal to
liabilities. For instance, if a firm raises funds through 364 days commercial paper and uses the
money to buy a plant. There is a asset-liability mismatch between the sources and uses of funds.
Suppose, the interest rate is 10% and expected return from the project is 12%. Today, the project
looks profitable. But what will happen when the interest rate increases to 13% from 10% at the end

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one year. If the commercial paper is renewed or new commercial paper is substituted for the same,
the project profitability turns negative. Further, what is the assurance that the company would be in
a position to roll-over the commercial paper or substitute a new paper. If there is delay or difficulty
in doing it, it will put lot of pressure on the part of organisation. Thus, prudential norms require use
of long-term funds for long-term purpose and short-term funds for short-term needs, which is
mainly working capital. Since it is difficult to exactly match this way, normally, if the flow is from
long-term sources to short-term uses, then it is considered to be a good funds management. Here
again, too much of excessive use of long-term funds for short-terms is not good. Funds flow
statement shows how efficient the firm is in managing two sources of funds.

Funds flow statement is also useful to ascertain whether the firm is liquid or not and whether the
firm is in a position to raise funds from operation to sustain its activities. If the firm has set some
budgets, which show the funding pattern of future expansion, funds flow statement will be useful to
compare whether we are able to achieve the budget terms. If the funds flow statement is prepared
for the future years, then it is possible for the management to plan in advance how to manage the
funds and what steps need to be taken today to raise different sources of funds.

An analysis of working capital statements will be useful to know where the need for working capital
arises. Other things being equal, it is desirable to reduce the working capital since investments in
working capital yield very low return or zero return. It is also possible to compare this statement
with budgets to control the growth of working capital.

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