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Q.1 Write a detailed note on fund flow statements as an Analytical Tool?

Funds Flow Statement


Funds Flow Statement is an an analytical tool in the hands of financial manager.
The basic purpose of this statement is to indicate on historical basis the changes in the
working capital i.e., where funds came from and were there are used during a given
period.

The utility of this statement can be measured on the basis of its contributions to the
financial management. It generally serves the following purposes:-

(1) Analysis of Financial Position. The basic purpose of preparing the statement is to
have a rich into the financial operations of the concern. It analyses how the funds were
obtained and used in the past. In this sens, it is a valuable tool for the finance manager for
analyzing the past and future plans of the firm and their impact on the liquidity. He can
deduce the reasons for the imbalances in uses of funds in the past an take necessary
corrective actions. In analyzing the financial position of the firm, the Funds Flow
Statement answers to such questions as-

1. Why were the net current assets of the firm down, though the net income was up or
vice versa?
2. How was it possible to distribute dividends in absence of or in excess of current
income for the period ?
3. How was the sale proceeds of plant and machinery used ?
4. How was the sale proceeds of plant and machinery used ?
5. How were the debts retired ?
6. What became to the proceeds of share issue or debenture issue ?
7. How was the increase in working capital financed ?
8. Where did the profits go?
Though it is not an easy job to find the definite answerers to such questions because
funds derived from a particular source re rarely used for a particular purpose. However,
certain useful assumptions can often be made and reasonable conclusions are usually not
difficult to arrive at.

(2) Evaluation of the Firm’s Financing. One important use of the statement is that it
evaluates the firm’ financing capacity. The analysis of sources of funds reveals how the
firm’s financed its development projects in the past i.e., from internal sources or from
external sources. It also reveals the rate of growth of the firm.

(3) An Instrument for Allocation of Resources. In modern large scale business, available
funds are always short for expansion programmes and there is always a problem of
allocation of resources. It is, therefore, a need of evolving an order of priorities for
putting through their expansion programmes which are phased accordingly, and funds
have to be arranged as different phases of programmes get into their stride. The amount
of funds to be available for these projects shall be estimated by the finance with the help
of Funds Flow Statement. This prevents the business from becoming a helpless victim of
unplanned action.
(4) A Tool of Communication to Outside World. Funds Flow Statement helps in
gathering the financial states of Business. It gives an insight into the evolution of the
present financial position and gives answer to the problem ‘where have our resources
been moving’? In the present world of credit financing, it provides a useful information
to bankers, creditors, financial, it provides a useful informations and government etc.
regarding amount of loan required, its proposes, the terms of repayment an sources for
repayment of loan etc. the financial manager gains a confidence born out of a study of
Funds Flow Statement. In fact, it carries information regarding firm’s financial policies to
the outside world.

(5) Future Guide. An analysis of Funds Flow Statements of several years reveals certain
valuable information for the financial manager for planning the future financial
requirements of the firm and their nature too i.e. Short term, long-term or mid term. The
management can formulate its financial policies based on information gathered from the
analysis of such statements. Financial manager can rearrange the firm’s financing more
effectively on the basis of such information along with the expected changes in trade p
payables and the various accruals. In this way, it guides the management in arranging its
financing more effectively.

Meaning of Fund Flow


The financial statement of the business indicate assets, liabilities and capital on a
particular date and also the profit or loss during a period. But it is possible that there is
enough profit in the business and the financial position is also good and still there may be
deficiency of cash or of working capital in business. If the management wants to find out
as to where the cash is being utilized, financial statement cannot help. Therefore, a
statement is prepared of the sources and applications of funds from where Working
Capital comes and where it is utilized. This is called Fund Flow statement.
Meaning of ‘Fund’
In a popular and generally accepted sense the term ‘fund’ is used to denote the excess of
current assts over current liabilities :

Working Capital = Current Assets – Current Liabilities

Meaning of ‘Flow’ of Fund


Flow of funds means transmigration (coming and going) of funds. In other words, Flow
of funds means change in Working capital, as in funds flow statement the words ‘funds’
mean net working capital.
Definition:
According to R.N. Anthony, “Fund Flow is a statement prepared to indicate the increase
in cash resources and the utilization of such resources of a business during the accounting
period.”
According to Smith Brown, “Fund Flow is prepared in summary form to indicate
changes occurring in items of financial condition between two different balance sheet
dates.”
FUNDS FLOW STATEMENT
Introduction
Many changes take place in the assets, equities, revenues and expenses in the course of
business operations. These changes in an asset or an equity account or in revenue or an
expenses account over a period of time can be examined and presented in the form of a
flow statement. The flow statement may, therefore be defined as a statement which
explains increases or decreases in different related accounts for a specified period of time.
These flow statements can be classified into four categories;
1. Income Statement
2. Funds Flow Statement
3. Statement of Changes in Financial Position
4. Cash Flow Statement

RULES OF FUNDS FLOW STATEMENT


The following are the general rules:
1. There will be Flow of Funds if a transaction involves
a. Current assets and fixed assets, e.g. Purchase of building for cash.
b. Current and Capital, e.g. Issue of shares for cash
c. Current and fixed liabilities e.g., Redemption of debentures in cash.
d. Current liabilities and fixed liabilities e.g., creditors paid of in debentures.
f. Current liabilities and fixed assets e.g., building transfer to creditors in satisfaction of
their claims.
2. There will be no flow of funds if transaction involves
a. Current assets and current liabilities e.g., payment made to creditors.
b. Fixes assets and fixed liabilities e.g., Building purchased and payment made in
debentures.

NEED FOR FUNDS FLOW STATEMENT


The Funds Flow Statement is widely used by the financial analysis and credit granting
institutions and financial managers in performance of their jobs. It has become a useful
tool in their analytical kit. This is because the financial statements, i.e., “Income
Statement” and the “Balance Sheet” have a limited role to perform. Income Statement
measures flow restricted to transitions that pertain to rendering of goods and services to
customers. The Balance Sheet is merely a static statement. It is a statement of assets and
liabilities as on a particular date.

USES OF FUNDS FLOW STATEMENT


Funds flow statement helps the financial analyst in having a more detailed analysis and
understanding of changes in the distribution of resources between two balance sheet
dates. In case such study is required regarding the future working capital position of the
company, a projected funds flow statement can be prepared. The uses of a funds flow
statement can be put as follows:
i. It explains the financial consequences of business operations:
Funds flow statement provides a ready answer to so many conflicting situations, such as:
a. Why the liquid position of the business is becoming more and more unbalanced in
spite of business making more and more profits?
b. How was it possible to distribute dividends in excess of current earnings or in the
presence of a net loss for the period?
c. How the business could have good liquid position in spite of business making losses or
acquisition of fixed assets?
ii. It answers intricate queries: The financial analyst can find out answers to a number of
intricate questions:

Advantages of Funds Flow Statement


The chief advantages of the Funds Flow Statement are the following:-
1. Since it gives the figures of cash inflow from operations, it gives much more reliable
picture of the results of operations than the usual profit and loss account. Changing the
amount of depreciation can easily change the figure of profit. Higher depreciation will
mean lower profit and vice versa.
2. Since cash (or funds) is the basis for carrying on operation, the funds flow statement,
prepared on an estimated basis for the next period will enable a firm, to plan its financial
operations properly. The firm will know how much funds it requires, how much it should
make arrangements from outside. This is a process of budgeting.
3. The statement for the previous year compared with the budget prepared before the year
commenced will show to what extent the resources for the company or the firm were
used according to plan to what extent the utilization was unplanned or not proper. The
funds Flow Statement cannot take the place of the final statements of account-the
Balance Sheet or the Profit and Loss Account-but it is most useful supplementary
statement.

Ref:
http://www.managementparadise.com/forums/archive/index.php/t-
193463.html

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