Funds Flow and Cash Flow

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Financial statements like the profit and loss statement and the balance sheet provide only limited information about the financial activities of a business. They do not give a complete report of the financial activities of all resources provided and the uses of financial resources during the period to which they are put. Therefore we have a   Funds Flow Statement

·         A funds flow statement is a financial operation statement.

·         It reveals how a business has been financed and the category of uses of its funds over a period of time.

·         The funds flow statement indicates changes in working capital.

·         It presents funds represented between different assets and equity items during an accounting period.

·         It is a means of analyzing in detail the items contained in the Balance Sheet, by linking the increase and decrease in certain figures not found in the balance sheet.

 

FUNDS FLOW STATEMENT:

1^st Step: Showing change in working capital.

Identify current assets and current liabilities in the Balance Sheet

CURRENT ASSETS	CURRENT LIABILITIES
Cash in hand	Bank Overdraft
Cash in bank	Dividend declared and Payable
Accounts Receivable	Income Tax Provision
Pre-paid expenses	Accounts Payable
Preliminary Expenses	Outstanding Liabilities for expenses
Debtors	Creditors
Inventory or Stock in Trade,

 

·         Record the difference in amounts in Current Assets and Current Liabilities for the current and last year’s balance sheet.

·         Working capital increases with an increase in current assets and/or decrease in current liabilities and is considered as an application of funds.

·         Working capital decreases with a decrease in current assets and/or increase in current liabilities and is also considered as a source of funds.

 

2^nd Step: Construction of the fixed assets account

Compare the opening and closing balances of these accounts.

Pass the necessary entries for the

·         Sale

·         Transfer from ‘provision for depreciation account’ showing accumulates depreciation on the asset sold. Separate accounts for each of the fixed assets should have been opened and maintained

·         Subsequent transfer to the profit and loss account of any profit or loss on sale.

·         Purchases of fixed assets

·         The difference in the account if depicting additions; will be taken as an application of funds.

·         Sales proceeds will be taken as a source of funds.

Similarly, the provision for taxation accountshould be constructed.

·         The opening and closing balances of provision for taxation should be noted. This information is contained in the opening and closing balance sheet.

·         The amount of tax paid should be debited to this account.

·         The amount of provision made for the year will be noted in the credit side of this account and the debit side of profit and loss account.

Similarly, an account is to be opened in respect of investmentsto ascertain the amount of purchase and sale of investments during the year.

3^rd Step: Preparation of adjusted profit and loss account

·         The opening and closing balances of this account will be noted.

·         Profits from operations are arrived at by adjusting non- cash items as mentioned above like depreciation, provision for taxation, loss or profit from sale of assets, and others like write- off of goodwill and preliminary expenses.

4^th Step: Scrutiny of long term liabilities and non-current or fixed assets

·         Note the changes in balances at the beginning and the end of the year

·         The differences are then listed either as a source or application of funds.

·         Profit on revaluation of fixed assets will not affect working capital and is not considered in the funds statement.

·         Dividends and interim dividends paid during the year should be shown as an application and charged to the adjusted profit and loss account.

The sources and applications summarized

Sources of Funds:

1.       Funds from normal operation of the business as disclosed by the closing balance of the profit and loss account.

2.       Other funds from sale of fixed assets or investments or issue of shares and debentures

Application of Funds:

1.       Operating Loss

2.       Purchase of fixed assets

3.       Purchase of Investments

4.       Payment of dividend

5.       Redemption of shares or other long term liabilities

 

In conclusion we can observe that when the inflows and outflows of fund result in net inflow, there in an increase in working capital and vice versa.

CASH FLOW STATEMENT:

A cash flow statement explains the cash movements between two points of time. It is used in the sense that it indicates the amount of resources provided by operations, and the net income is adjusted for depreciation and certain other changes. This is useful for the management in budgeting cash requirements. It is useful for creditors and investors also. The cash statement is prepared according to the accounting standard of the country.

1.       Commence with the opening cash and bank balances

2.       Add the amount of cash received as in issue of shares and debentures, receipt from debtors and sale of fixed assets.

3.       Deduct payments: to creditors, to other liabilities and expenses, to acquire assets and to pay dividend and taxation.

4.       The balance will represent the closing cash and bank balances

When figures for purchases, sales and expenses are not available, the statement will be prepared in the same way as sources and application of funds statement. Increase and decrease in each of the current asset and current liabilities are shown in the statement of changes in Working Capital.  This movement of working capital should relate with the overall changes in the movement of sources and uses (of long term capital, operating results and fixed assets) statement.