Funds Flow Statement: Meaning, Rules and Advantages

In this article we will discuss about the Funds Flow Statement:- 1. Meaning of Funds Flow Statement 2. Rules for Drawing up the Funds Flow Statement 3. Advantages 4. Limitations.

Meaning of Funds Flow Statement:

Accounting Standard (Revised)-3 has made Funds Flow Statement obsolete. Hence, the following description is meant only for those who may, for some reasons, still be required to prepare a Funds Flow Statement.

Funds mean the net working capital i.e., current assets minus current liabilities. Funds Flow Statement is a statement which lists first all the sources of funds and then all the applications of funds that have taken place in a business enterprise during the particular period of time for which the statement has been prepared.

The statement finally shows the net increase or net decrease in the working capital that has taken place over the period of time. This statement is also called “Statement of Sources and Applications of Funds” or even “How Come Where Gone Statement”.

Usually along with Funds Flow Statement a “Statement Showing Changes in Working Capital” also called “Working Capital Statement” is also prepared for the same period for which Funds Flow Statement is prepared. In this statement, all the individual current assets and current liabilities in the beginning as well as at the end of the period are first noted.

Then increase or decrease in working capital due to increase or decrease in each such item is recorded. Finally, the overall net increase or decrease in working capital over the period is found out. This figure is the same as the one that appears by way of net increase or decrease in working capital in Funds Flow Statement.

The following is an example of Funds Flow Statement and Statement Showing Changes in Working Capital:

Rules for Drawing up the Funds Flow Statement:

To prepare a Funds Flow Statement, sources and applications of funds have to be ascertained.

The usual sources of funds for a joint stock company are as follows:

(i) Funds from Trading Operations:

It is an internal source of funds. To ascertain it, take the figure of net profit for the year as per Profit & Loss Account. This is the figure of net profit after depreciation and provision of income tax for the year but before any appropriations for the year like transfer to General Reserve, Debenture Redemption Reserve etc.

To this figure of net profit, add the following amounts:

(a) Depreciation on fixed assets

(b) Goodwill, Preliminary Expenses, Cost of Issue of Debentures etc., written off during the year.

(c) Loss on sale of fixed assets.

(d) Loss on sale of investments.

From the total, deduct the following amounts:

(a) Profit on sale of fixed assets

(b) Profit on sale of investments

(c) Profit on revaluation of fixed assets

(d) Non-operating incomes.

(ii) Issue of Shares:

Issue of shares for cash or for any other current asset or in discharge of a current liability is another source of funds. However, shares allotted in consideration of some fixed assets will not result in funds. However, it is recommended that such purchase of fixed assets as well as issue of securities to pay for them be revealed in Funds Flow Statement.

Actual collection on issue of shares should be recorded. For example, if shares have been partly called up, only that part which has actually been received will be shown as a source of funds. If shares have been issued at a premium, the amount of share premium collected will also be included.

If on the other hand, shares have been issued at a discount, the amount of the discount will be deducted to ascertain the amount collected. Also, shares might have been allotted in an earlier period, and in the period for which Funds Flow Statement is prepared only a call might have been made. In such a case, the amount of the call collected will be a source of funds.

(iii) Issue of Debentures:

Whatever has been said about shares in (ii) above holds good for debentures also.

(iv) Raising of Long-term Loans from Financial Institutions:

Like debentures, long-term loans from financial institutions form a source of funds.

(v) Sale Proceeds Affixed Assets and Long-term Investments:

As sale proceeds of fixed assets and long-term investments are noted as separate items of sources of funds, the effect of any profit or loss on their disposal is removed from the figure of net profit as per Profit & Loss Account before noting it as a source of funds from trading operations so that there may be no double counting.

(vi) Non-operating incomes are also a source of funds.

The usual applications of funds are as follows:

(i) Purchase of Fixed Assets:

Purchase of fixed assets for cash or some other current asset or on short-term credit causes reduction of funds.

(ii) Purchase of Long-Term Investments:

Such a purchase is mostly for cash and hence an application of funds.

(iii) Redemption of Preference Shares and/or Debentures:

Payment made to redeem these securities is an application of funds. However, if preference share or debentures are converted into equity shares, it will not result in an application of funds. But for the sake of disclosure, issue of shares on such a conversion as well as redemption of the securities by conversion should be shown in Funds Flow Statement.

(iv) Repayment of Long-term Loans also entails applications of funds.

(v) Payment of Dividend-It is a very frequent application of funds.

(vi) Payment of Income Tax-Amount paid by way of income tax will be shown as an application of funds if Provision for Income Tax is treated as an appropriation of profits rather than as a current liability. In the Income Statement of a joint stock company, Provision for Income Tax is shown above the line and not in the Profit & Loss Appropriation Account.

Hence, Provision for Income Tax may be treated as a current liability. In such a case, payments of income tax will not appear as an application of funds.

However, if one takes the view that as income tax is a tax on income. Provision for Income Tax should be treated as an appropriation of profits for purposes of preparation of Funds Flow Statements. In that case, while ascertaining Funds from Trading Operations, Provision for Income Tax should be added to the figure of net profit after tax.

Provision for Income Tax will not appear in the Schedule of Changes in Working Capital and the amount of income tax paid will be shown as an application of funds.

It is to be borne in mind that the statement should bring out the significant factors which have led to the change in the funds position of the company or the firm without giving too many details, for details often hides the important factors from view. Taking the above into account, the statement should show up all new features if they are of significance.

For instance, if a company has newly resorted to bank overdrafts, these should be shown as a separate source; this will also be the case if there is a big increase in it or a similar other source. But if bank overdraft is a normal feature and the amount does not change much from year to year, it may not be shown separately; the working capital figure will be adjusted for the purpose.

Advantages of Funds Flow Statement:

The following are the main advantages of Funds Flow Statement:

(i) It gives the figure of flow of funds from operations which are in one way, more reliable than the figure of net profit revealed by profit and loss account.

The amount to be charged in respect of depreciation often depends on the management’s decisions and hence the figure of profit revealed by the profit and loss account may sometimes be unrealizable. In the funds flow statement, the effect of depreciation and other non-cash charges is eliminated.

(ii) Comparison of the figures of working capital budget with the figures of sources and applications of funds in the funds flow statement enables the management to ascertain how for the budget has been implemented. It also helps in the preparation of the budget for the subsequent period.

Limitations of Funds Flow Statement:

Funds flow statement shows flows of net working capital which includes items like stock of goods and prepaid expenses which do not contribute to the short term ability of the enterprise to pay its debts. Because of its limitations, AS (Revised)-3 has done away with it and has recommended the preparation of cash flow statement. SEBI also requires the listed companies to prepare cash flow statement.