How to Prepare Funds Flow Statement? (With Stages) | Financial Accounting

Funds flow statement is a method by which we study changes in financial position of a business enterprise between two accounting periods. It is prepared with the help of two balance sheets of an enterprise. Broadly speaking, preparation of funds flow statement involves two stages, namely –

1. Statement or schedule of changes in working capital

2. Statement of sources and uses of funds

Working capital is the excess of current assets over current liabilities. Statement of changes in working capital is prepared to know the changes in working capital between two balance sheet dates.

Working capital = Current assets – Current liabilities

Therefore,

1. An increase in current asset or decrease in current liability will result in increase in working capital and

2. A decrease in current asset or increase in current liability will result in decrease in working capital.

Thus, we find that the changes in the items of current assets are positively consulted to the changes in the working capital. On the other hand, changes in the current liabilities are inversely related to the changes in the working capital.

A Performa of schedule of working capital changes is given in Table.

While preparing the statement of changes in working capital, it is necessary to identify correctly the current assets and current liabilities of the firm, and only these current assets and current liabilities have to be considered in the schedule of changes in working capital. Any additional information pertaining to their current assets and current liabilities should outright be ignored unless these are not incorporated into the books of accounts.

Statement of Sources and Application of Funds:

Funds flow statement is a statement which indicates various sources from which funds have been obtained during a certain period and application/uses of their funds have been put during that period.

This statement is prepared in two formats:

(a) Report form

(b) T form/account form/self-balancing type

To prepare a funds flow statement, it is necessary to find out the “sources” and “applications” of funds.

Sources of Funds:

The sources of funds can be both internal and external.

Internal Sources of Funds:

Funds from operations is the only internal source of funds. However, the following adjustments will be required in the figure of net profit for finding out real funds from operations. As profit and loss is prepared on the basis of accrual concept, the following adjustments need to be done.

Add the following items as they do not result in inflow of funds:

(a) Depreciation on fixed assets

(b) Preliminary expenses/goodwill, etc., written off

(c) Contribution to debenture reserve funds, transfer to general reserve fund, if they have been deducted before airing of the net profit.

(d) Provision for taxation and proposed dividends

(e) Loss of sale of fixed assets

Deduct the following items as they do not increase funds:

(a) Profit in sale of fixed assets, since the full sale proceeds are to be taken as a separate source of funds and inclusion will result in duplication.

(b) Profit on revolution of fixed assets.

(c) Non-operating incomes, such as dividend received or accrued dividend, refund of income tax, rent received or accrued rent. There items increase funds but they are non-operating income. They should be shown separately under sources of funds in the “funds flow statement.”