Preparation of Fund flow Statement
Before preparing a Fund Flow Statement, it is essential to understand the following:
- Classification of Balance Sheet
- Meaning of Fund
- Meaning of Flow
1. Classification of Balance Sheet
Items mentioned in the Balance sheet have been explained below:
All liabilities payable over a period longer than one year are non-current liabilities. Non-current liabilities also include share capital, share premium, Loss Account (Cr. balance), and all reserves.
All liabilities which are payable within one year are known as current liabilities such as B/P, Creditors etc. long-term loans, if maturing with in one year, should also be treated as current liabilities, but only if long-term funds are not raised to pay them off. Provision against current assets like provision for doubtful debts is also treated as current liabilities.
The assets which are put to use in the business for a long time are non-current assets. The object is not to resell them.
The assets which are reasonably expected to be realized in cash or sold or consumed within one year are termed as current assets. These assets continue changing.
2. Meaning of Funds
In a limited sense, the term ‘fund’ means ‘cash’. But this is not the correct meaning of the term ‘fund’ because there are many transactions in the business which do not result in inflow or outflow of cash but certainly result in the inflow or outflow of funds. For example, a machine is purchased on two months credit. Although cash is not immediately affected by this transaction, it certainly results in an outflow of funds. As such, the term ‘fund’ stands for ‘Working Capital’. Working Capital = Current Assets – Current Liabilities.
3. Meaning of Flow
The term ‘flow’ means change or movement. Therefore, the term ‘Flow of Funds’ means ‘change in funds’ or ‘change in Working Capital’. In other words, ‘FLOW of Funds means increase or decrease in working capital. Every Transaction will have one of the followings effect:
- If a transaction results in the increase of working capital, it is said to be a source of funds.
- A transaction results in the decrease of working capital, it is said to be an application of funds.
- If the transaction does not result in any change in the working capital, it is said that it does not result in the flow of fund.
While preparing Fund Flow Statement Usually,
- Schedule of Changes in working capital is prepared and
- Fund From Operations is calculated
1. Preparation of Schedule of Changes in working capital:
This schedule considers only current assets and current liabilities, at the end of the year and at the beginning of the year. This schedule shows either increase or decrease in working capital. Following rules are followed while preparing a Schedule of Changes in working capital:
- An increase in Current Assets ……………………… results in increase in working capital
- A decrease in Current Assets ……………………… results in decrease in working capital
- An increase in Current liabilities…………………… results in decrease in working capital
- A decrease in Current Assets ……………………… results in increase in working capital
Note: Schedule of changes in working capital is prepared only from items given in balance sheets. There will be no effect of the additional information given at the end of the question.
2. Calculation of Funds from Operations:
In order to prepare funds flow-statement it is necessary to ascertain the sources-and application of funds. Main source of fund in a business is funds from Operations.
Funds from Operations: The figure of net profit shown by Profit & Loss Account is generally affected by some items which do not affect flow of funds, but which have already been debited or credited. Therefore, the funds from operations can be calculated by adding or deducting these non-fund items from the net profit shown by Profit & Loss Account.
Preparation of Fund Flow Statement Involves
- Sources of Funds
- Application of Funds
1. Sources of Funds:
Funds from Operations
Profits resulting from business operations is most important source of funds. Computation of funds from operations has already been discussed.
Issue of Shares
When Shares are issued for cash they are source of funds. But when bonus shares are issued or shares are issued for some other consideration like fixed asset than it is not a source of funds.
Issue of Debenture and raising of loan etc
Issue of debentures or raising loans (long term) results in to flow of funds. The inflow of funds is the actual proceeds from the issue of such debentures or raising of loans, i.e. including the amount of premium or excluding discount, if any. However, loans rose for consideration other than a current asset, such as for purchase of building, will not constitute inflow of funds because in that case the accounts involved are only fixed or non-current.
Sale of Fixed (non-current) Assets and Long-term or Trade investments
When any fixed asset like land, building, plant and machinery etc. are sold it generates funds. However, it must be remembered that if one fixed asset is exchanged for another fixed asset, it does not constitute an inflow of funds because no current assets are involved.
Non- Trading Receipts
Any non-trading receipt like dividend received, refund of tax, rent received, etc. also increases funds and is treated as a sources of funds because such an income is not included in the funds from operations.
Decrease in Working Capital
If the working capital decreases during the current period as compared to the previous period, it means that there has been a release of funds from working capital and it constitutes a source of funds.
2. Application or Uses of Funds
In the preparation of Fund Flow statement, it is important to differentiate between uses and sources of funds. Uses of funds that comes in Fund Flow Statement are as follows –
Funds lost in operations
Sometimes the result of trading in a certain year is a loss and some funds are lost during that period in trading operations. Such loss of funds in trading amounts to an outflow of funds and is treated as an application of funds.
Redemption of preference share capital
If during the year any preference shares are redeemed, it will result in the outflow of funds and is taken as an application of funds. When the shares are redeemed at premium or discount, it is the net amount paid. (Including premium or excluding discount, as the case may be). However, if shares are redeemed in exchanges· of some other type of shares or debentures, it does not constitute an outflow of funds as no current account is involved in that case.
Repayment of loans or redemption of debentures, etc
In the same way as redemption of preference share capital, redemption of debentures or repayment of loans also constitutes an application of funds.
Purchase of any non-current or fixed asset
When any fixed or non-current asset like land, building, plant and machinery, furniture, long-term investments, etc. are purchased, ‘funds outflow from the business. However, if fixed assets are purchased for a consideration of issue of shares or debentures or if some fixed asset is exchanged for another, it does not involve any funds and hence not an application of funds.
Payments of dividends and tax
Payments of dividends and tax are also applications of funds. It is the actual payment of dividend (may be interim dividend) and tax which should be taken as an outflow of funds and not the mere declaration of dividend or creating of a provision for taxation.
Any other non-trading payment
Any payment or expense not related to the trading operations of the business amounts to outflow of funds and is taken as an application of funds. The examples could be drawings in case of sole trader or partnership firms, loss of cash, etc.