Statement of Changes in Financial Position: An Overview

In this article we will discuss about the Statement of Changes in Financial Position:- 1. Concept of Statement of Changes in Financial Position 2. Preparation of Statement of Changes in Financial Position 3. Significance 4. Limitation.

Concept of Statement of Changes in Financial Position:

A Statement of changes in financial position (funds statement) helps us to understands how and why a business enterprise has acquired its resources and what those resources were used for.

The objectives of funds statement are:

(1) To summarise the financing and investing activities of the entity, including the extent to which the enterprise has generated funds from operations during the period and

(2) To complete the disclosure of changes of financial position during the period.

Preparation of Statement of Changes in Financial Position:

Concept of Funds:

A statement of changes in financial position can be prepared using different concepts of funds as a basis. For instance, statement of changes in financial position may focus on changes in working capital, cash, or total financial resources of a business enterprise.

Accordingly, the preparation of the following types of statement of changes in financial position:

(1) Statement of changes in working capital, popularly known as Funds Flow Statement or Statement of Sources and Applications of funds.

(2) Statement of changes in cash popularly known as Cash Flow Statement.

(3) Statement of changes in Total Financial Resources.

Main Steps in Preparing the Statement:

In order to prepare a statement of changes in financial position on a working capital basis, it is necessary to have balance sheets at two points in time and an income statement covering that span of time.

The steps involved in preparing the statement are as follows:

1. Determine the change (increase or decrease) in working capital.

2. Determine the adjustments account to be made to net income.

3. For each non-current account on the balance sheet, establish the increase or decrease in that account. Analyse the change to decide whether it is a source (increase) or use (decrease) of working capital.

4. Be sure the total of all sources including those from operations minus the total of all uses equals the change found in working capital in step 1.

General Rules for Preparing Funds Flow Statement, Working Capital Basis:

The following general rules should be observed while preparing funds flow statement:

1. Increase in a current asset means increase (plus) in working capital.

2. Decrease in a current asset means decrease (minus) in working capital.

3. Increase in a current liability means decrease (minus) in working capital.

4. Decrease in a current liability means increase (plus) in working capital.

5. Increase in current asset and increase in current liability does not affect working capital.

6. Decrease in current asset and decrease in current liability does not affect working capital.

7. Changes in fixed (non-current) assets and fixed (non-current) liabilities affects working capital.

Significance of Statement of Changes in Financial Position —Working Capital Basis:

A better understanding and analysis of the affairs of a business enterprise requires the knowledge about the movements in assets, liabilities and capital which have taken place during the year and their consequent effect on its financial position. This information is not specifically disclosed by a profit and loss account and balance sheet but can be made available in working capital based funds flow statement.

The funds flow statement is in no way a replacement for the profit and loss account and balance sheet although the information which it contains is a selection, reclassification and summarisation of information contained in these two statements. The balance sheet gives a “snapshot” view at a point in time of the sources from which a firm has acquired its funds and the uses which the firm has made of these funds.

The equities side of the balance sheet delineates these sources, and the asset side shows the uses. The income statement is a flow statement; it explains changes that occurred in the profit and loss account by summarizing the increases (revenues) and decreases (expenses) in net profit during the accounting period.

A funds flow statement explains the changes that took place in a balance sheet account or group of accounts during the period between dates of two balance sheets “snapshots.” it shows the manner in which the operations of an enterprise have been financed and in which its financial resources have been used.

It also distinguishes the use of funds for the long-term from the short- term. For example, it distinguishes the use of funds for the purchase of new fixed assets from funds used in increasing the working capital of the company.

Thus, it provides a meaningful link between the balance sheets at the beginning and at the end of a period and profit and loss account for that period. It should be understood, however, that a funds statement does not purport to indicate the requirements of a business for capital.

The concept of working capital is in conformity with normal accrual accounting procedures. Hence, a funs flow statement based on the concept of net working capital fits well with other statements.

Above all, working capital is also a measure of the short-term liquidity of the firm. Therefore, an analysis of factors bringing about a change in the amount of net working capital is useful for decision-making by shareholders, creditors, lenders and management.

Limitation of Statement of Changes in Financial Position —Working Capital Basis:

The working capital concept of funds enlarges the problem of valuation because it includes inventory and prepaid items. Thus, the measurement of working capital flows is less precise than for cash.

A fund statement based on the working capital concept is usually a brief presentation, and many significant inter-firm transactions are not disclosed. For example, significant addition to inventories financed by short-term credits would not be shown because the two items are offset in the computation of the net change in working capital.

Furthermore, transactions not affecting working capital, such as the acquisition of plant and equipment by the issuance of equity capital, would not be included in the statement. Therefore, the funds statement in this presentation would not disclose structural changes in the financial relationships in the firm or major changes in policy regarding investments in current assets and short-term financing.

Illustration:

The Balance Sheets of H Ltd. are given below for the year 2006 and 2007:

 

Additional Information:

(i) During the year 2007 fixed assets value at Rs. 20,000 (accumulated depreciation Rs. 60,000) was sold for Rs. 16,000.

(ii) The proposed dividend of last year was paid during 2007.

(iii) During the year 2007, investments costing Rs. 1,60,000 were sold and later in the year investments of the same cost were purchased.

(iv) Debentures were redeemed at a premium of 10%.

(v) Liability for taxation for 2006 came to Rs. 1,10,000.

(vi) During the year 2007, bad debts written off were Rs. 30,000 against the provision amount.

Prepare:

(i) A Statement of Changes in Working Capital

(ii) And Statement of Changes in Financial Position.