In this article, we will see and understand what the purpose of fund flow statement is. The important terms such as funds and flows we will have look on it. There is difference in between fund flow statement and in balance sheet and Profit and Account, that difference we will see in this interesting article. Fund flow statement is used to identify the various transactions which mainly cause the changes in the funds. The measurement of trading performance, operational efficiency and most importantly profitability and off course financial position of the company can be done with the help of Trading account, Profit and Loss Account and Balance sheet. So do you know, what are all things which are used for finding out Gross profit or Gross loss? Yes, trading account, Profit and Loss Account and Balance sheet are used for finding out Gross profit or Gross loss, even further tasks such as net profit, net loss and the most important financial soundness of the firm. This is applicable for particular period of time. Fund flow statements are very important with respect to management point of view. The information available in fund flow statement is efficiently and effectively used for various analysis and management. Fund flow statement plays vital role for not only management of firm but also to creditors and investors also, in order to evaluate or determine, the various sources of money so called funds for firm or company. As of now we have seen the various aspects of management but there are other aspects associated with it also. There is need of analysis of not only movements of assets, but also liabilities. There is also need of analysis of movement of funds from operation and capital as well. This capital considered is in between two financial years. The information provided in these statement is meaning fully used in the various analysis and future forecasting as well. So fund flow statement is very important in various important management aspects of the organization.
In upcoming section we will see the meaning of funds and meaning of flow of funds.
What is meaning of funds?
Basically, the term fund is refers to Cash. It is also refers to working capital or to cash equivalent which involved in the business. The business mainly includes various aspects such as men, money, plant along with various kinds of equipments, off course the material and apart from it the other things which plays major role in the business. If you are aware of working capital, then fund is broadly refers to working capital of firm. Do you want to know what working capital is? Then here is the explanation of it. The difference between current assets and current liabilities is nothing but the working capital. Working capital is mainly divided into two parts and these are, Gross working capital and Net working capital. Here Gross working capital mainly represents the total of the entire current asset with the firm. While Net working capital is referred for excess of current assets over the current liabilities. So finally we can say that cash or cash equivalent is nothing but the fund with respect business.
What is meaning of flow of funds?
During the normal working course of business, the changes or movements of funds or even the changes in the working capital of business is called as flow of funds. If you know the inflow of working capital or outflow of working capital then you are well aware of what is result of it? Capital changes i.e. working capital, cause inflow of working capital or outflow of working capital. If there is increase in working capital or decrease in working capital cause the flow of money i.e. fund, so the flow of fund occurs. Suppose there are several component of working capital and it causes the increase in the funds, and then is known as inflow of funds. On the same line, if there are several components of working capital and it causes the decrease in the funds it is known as outflow of funds. We can put example for it, if some shares are brought to raise fund such increase in the fund is called inflow funds. If we consider another example of buying the machinery for business, to purchase machinery result in decrease in the funds. Such decrease in the funds is called outflow of funds. This is because, it causes the decrease in the flow of the funds.
What is meaning of no flow of funds?
There are also some transactions which take place but does not have any influence on the increase or decrease in the fund of working capital. These transactions are involved in the business purpose or business concern only. If we want to put an example for it, then the good example for it would be transactions which occur in current assets and the current liabilities do not cause any fund flow. Also the transactions which occur in non-current assets and non-current liabilities do not take part in causing flow of funds. One more example is the transactions in between non-current accounts which do not take part in increase or in decrease of working capital position. So as we have discussed in this section, there are some transaction which are involved in the flow of funds but still important in the business.
What is statement of changes in financial position?
Using resources i.e. financial resource such as liabilities, assets and capital the statement of Changes in Financial Position is prepared. Statement of Changes in Financial Position is used in order to measure changes in non-current and also current account. In the next mentioned transactions the changes in the financial position of the business. The transactions occur in between current asset and non-current assets. Second transaction example is the transaction between current liabilities and non-current assets. The third example of transaction is the transaction between current asses and non-current liabilities. The fourth and final example of transaction is the transaction between current liabilities and non-current liabilities.
What are the components of flow of funds?
Till now we have seen various aspects of flow of funds. Now it is time of know about components of flow of funds. Components of flow of funds are used to analyze fund sources and fund applications. So let's see these components. There are mainly six components of flow of funds exists. These components are current assets, non-current asset or popularly known as fixed or permanent assets, current liabilities, non-current liabilities also known as capital and long-term liabilities, provision of tax and last one is I proposed dividend.
In upcoming part of this article we will see these components in detail.
- Current assets:
Current assets are those assets which are meant for resale. These can be converted into other form during the business period which is predefined. So the assets which are transitory in nature are called as Current assets which occur during the course of business period. If we look at the raw material example, in this case, the raw material is purchased, it is processed by labour. The finished product is sale. Even after, all the raw material is not converted into the finished good. The remaining raw material is called as the current asset. Apart from it, the labours which are working for making finished good are also come into current assets.
- Non-current asset i.e. fixed or permanent assets:
Non-current assets or popularly known as permanent assets are those assets which are tangible and also intangible assets. These assets are not consumed during the course of business, however it is specially meant for providing services. It also helps in producing saleable goods or products. These assets play a base role in the every aspect or task of business. So it is very necessary asset. Specifically, the land or building which forms basic foundation of any business is come into Non-current asset i.e. fixed or permanent assets. Apart from land, building other things such as plant and machinery, goodwill and also patents comes under non-current assets. The non-current or permanent Assets are goodwill, land, building, Plant and Machinery, Furniture and fittings, Trademarks, Patent rights, Long-term investments and discount which are on issue of shares and debenture.
- Current liabilities:
Current liabilities are those liabilities which are currently due for payment. Creditors which have to pay by business come under the current liabilities. Apart from creditors, other thing such as bank loan due for repayment and also the proposed dividend and off course the proposed tax is also comes into the category of current liabilities. If you want some more examples then here we go. Bills payable, Sundry creditors, outstanding expenses, dividends payable, bank overdraft, short term loans, provisions which are against the current assets, one more provision and it is against the taxation and one more example of current liabilities is proposed dividend it may be current or non-current liabilities.
- Non-current liabilities i.e. capital and long-term liabilities:
The capital and long term debt is generally referred as Non-current liabilities i.e. capital and long-term liabilities. Sometimes it is referred or called as permanent liabilities. If business is paying some amount continuously for a long period to someone year after year then it is treated as Non-current liabilities i.e. capital and long-term liabilities. Loans on mortgage, long-term loans and debenture are some examples which we can put here for Non-current liabilities i.e. capital and long-term liabilities. You want some more examples for Non-current liabilities i.e. capital and long-term liabilities. Then examples for permanent liabilities are equity share capital, debentures, preference share capital, long-term loans, share forfeited, share premium, profit and loss account, capital reserve, capital redemption reserve, preliminary expenses and other deferred expenses.
- Provision of tax:
The appropriation of profit or current liability is treaded for provision of tax or provision of taxation. When provision of taxation is done for given year i.e. during the same year in which business is running, in that case provision taxation is not used for adjustment of net profit. It must be treated as current liability. Application fund or non-current liability in this case is nothing but the amount of tax paid during the year of business. You may ask question why it is so, this is because net profit adjustment is done using provision of tax during the same year during which business is in running condition.
- Proposed dividend:
So we have seen that provision of taxation is treated as either current liability or non-current liability. Similarly, when dividend is declared it is considered as current liability or non-current liability. As like provision of taxation, proposed dividend is also not used for adjusting the net profit which is made during the year i.e. business period. This proposed dividend is used to analysis of the sources as well as application funds. So proposed dividend is also one of the important component for flow of funds.
What is fund flow statement?
Till this section we have seen basic concepts such as meaning of funds, flow of funds, no flow of funds, statement of changes in financial position, components of flow of funds etc. Now we are going to describe what is fund flow statement? Is it same as income statement? These queries will be get answered in this and upcoming sections. If there are two balance sheet dates and there are significant financial changes in financial position items and such changes occurred in between these mentioned dates then summery of it is mentioned through fund flow statement. Based on the working capital which is concept of funds this fund flow statement is prepared. During the course of business fund flow statement helps in measuring application of funds as well as sources of funds. So we come to know that fund flow statement plays a vital role in analysis.
Where got and where gone out statement, statement of sources and application of fund or inflow of funds and outflow of funds statement are some of the other terms for fund flow statement.
What is importance of fund flow statement?
Below are uses of fund flow statement which helps in financial analysis to meet need of people. Lets discuss the importance of fund flow statement as below-
- The different sources and applications or fund usage in between mention business period or accounting period is highlighted with the help of fund flow statement.
- It also helps show or highlights the weakness as well as strength of financial condition of the business.
- We can say fund flow statement is a tool which measure the causes of changes in financial condition or working capital
- With the help of fund flow statement analysis is done and in result corrective actions can be taken by the management. This is done during the situation where there is deviation is found in between two balance sheet data.
- At the time of investment proposals, investors usually use fund flow statement for effective decisions.
- The information about operational efficiency, profitability and financial aspects is described or presented with the help of fund flow statement.
- Fund flow statement acts as guide to not only management but also to everyone in order to derive retention policy, dividend policy or investment policy etc.
- Finance and investment related transaction process related consequences are effectively tackled with the help of it.
- If it required to know detailed information about the what are the uses of fund or where the fund has moved, then fund flow statement plays vital role in this process.
Fund flow statement, income statement and balance sheet:
Let's first explain fund flow statement here, the different sources, uses of funds during certain period is explained with help of fund flow statement. If you want to know regarding the format for preparation, then there is no surprise if it is said that there is no specific format in which this statement is prepared. The revenue and capital nature of income as well as expenditure is considered for this kind of statement. The flow of fund since operation starts are given with help of this statement. It helps to prepare income statement.
Let's discuss about the income statement, the net profit or loss in given business period is described by income statement. If we check the format for it, then double entry book keeping and prescribed format is used for it. Here capital nature is not considered but revenue nature of expenditure or income fund is considered. Income statement does not help to prepare fund flow statement.
So now, you may curious about to know what then balance sheet? Let have look on it. At the end of every account period, assets and liabilities are prepared with balance sheet. This is prepared on the Trial balance basis. Financial position of a concern as whole for defined period is explained by balance sheet. Balance sheet is prepared after profit and loss account and off course the trading account is finished.
Limitations of fund flow statement:
Till this point we have considered various aspect of fund flow statement. We discussed what uses of it are. The significance, importance of it is also discussed in previous section. Now it is time to discuss its limitation. Below are some limitations of Fund Flow Statement.
The statement is prepared based on historical data or information. This statement do not considered the future changes or future advantages.
The transactions which are not involved in non-fund items is not considered while preparation of fund flow statement.
Any additional information or analysis is not provided to management as it is simply a presentation
Transactions involved in between current accounts or non current accounts are ignored in it.
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