Definition of Fund Flow Statement, Objectives, Limitations
Fund Flow Statement Definition – A fund flow statement examines the sources and uses of funds of a firm between two points of time.
Fund flow statement is a statement which explains the change in the items of balance sheet over the period of time. The term “Funds” has been described in many ways. Many interpret funds as cash only. The fund flow statement prepared of this ratio is called a cash flow statement. In this type of statement only inflow and outflow of cash considers into account.
This narrow concept of cash flow often leads to omission of such items which do not directly affect cash or working capital. Thus the term funds flow refers to change in working capital. The sources and the composition of working capital at the end of the period are important factors in evaluating post activities. In addition to this, it also judges company’s ability to prosper in the future.
The fund flow statement is called by different names, namely sources and application of funds, sources and uses of funds, movements of funds statement and where got and where gone statement. This statement is prepared to indicate the increase in cash resources and utilization of such resources of a business during a given period.
The usefulness of a balance sheet is limited to analysis and planning purpose. It does not serve the purpose. Fund Flow Statement discloses the result or the policies followed by the financial management in a way which makes it more understandable to observe than the other financial statement.
Objectives of Fund Flow Statement:
The utility of this statement can be measured on the basis of its contribution to the financial management. It generally serves the following purpose:
1. Analysis Financial Position
The basic purpose of preparing the statement is to have a rich insight into sources and uses of funds in past. Fund Flow statement answers the following questions –
- Where were the net current assets of the firm down, though the net income was up or vice versa?
- How was it possible to distribute dividends in absence of or in excess of current income for the period?
- How was the expansion in plants and equipment financed?
- What became to the proceeds of shares issues or debentures issued?
- How was the sale proceed of plant and machinery used?
- How were the debts retired?
- Where did the profits go?
- How was the increase in working capital financed?
2. Evaluation of the Financing Capacity
One important use of the statement is that it evaluates the firms financing capacity. The analysis of sources of funds reveals how the firm the firm had financed its development project in the past.
3. Instrument for Allocation of Resources
In modern large scale business, available funds are always short for expansion programs and there is always a problem of allocation of resources. The amount of funds to be available for these projects shall be estimated by the finance manager with the help of fund flow statement. This prevents the business form coming a help less vision of unplanned action.
4. Tool of communication to outside world
Fund flow statement helps in gathering the financial states of business. In the present world credit financing it provides useful information to bankers, creditors, financial institution and governments regarding amount of the loan required, its purpose, the terms of repayment and sources for repayment of loan etc. It carries information regarding firms’ financial policies to the outside world.
5. Future guide
The management can formulate its financial policies based on information gathered from the analysis of such statement. Financial manager can rearrange the firms financing more affectivity on the expected changes in trade payables and the various accruals. In this guide the management in arranging it’s financing more effectively.
Funds statement supplies valuable information to the management and aid material in planning for expansion in dividend polices and other major programs. If handled properly, it gives information which is not available elsewhere.
Limitations of Fund Flow Statement
- Ignores certain non-fund transactions (such as issue of shares in consideration of purchase of fixed assets) which have equal bearing on the financial position of the firm just like other fund transactions.
- Reveals only the changes in working capital and does not show the changes in cash position. It is possible that there is sufficient working capital and yet the firm may be unable to meet its current liabilities due to shortage of cash. It may be due to sizeable piling up of inventories and an increase in debtors. In this case, firms prepare, cash flow statement.
- It is historical in nature because it reports what has happened in the past. It is quite difficult to predict the future operations on the basis of past records.
- Since it is based on opening and closing balance sheets and the profit and loss account, it is not a original statement which can provide an original evidence to the change in financial position.