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4- FUND FLOW STATEMENT Objectives of fund flow statement

 To know changes in working capital during a
Every firm prepares financial statements viz., P&L
period
a/c and Balance sheet to ascertain profit and to
 To understand working capital position of a
know financial position of the firm. Both these
firm
statements are static statements i.e. P&L shows
 To assess the financial condition of a firm
the working result for a period of time and
 A projected FFS helps in framing suitable
balance sheet shows the financial position on a
dividend policy
particular date.
 It indicates whether the resources have been
But the financial position of a firm changes with properly utilised or not.
every transaction. In other words, there is a
Importance/benefits/Uses of FFS
continuous movement of resources into the
1. Helps in analysis of financial operation-
business, within the business and out of the
financial statements provide net effect only.
business. Unfortunately, both P&L and Balance
They are static statements.
sheet does not explain the flow of fund during a
2. It gives answer to complex questions of
particular period of time. Two balance sheets of
general interest.
successive years may show some differences in
a. Why are net current assets lesser in spite of higher
the value of assets and liabilities but does not profits
throw light into the reasons for the change. To b. What happened to the profits? Where did they go?
overcome this limitation, a special device has c. What happened to the proceeds of issue of
been developed to study the movement of fund shares/debentures?
d. What are the sources of repayment of debt?
namely, Statement of Changes in Financial
3. It helps in setting up of proper dividend
Position.
policy.
There are two such statements, one on working 4. Proper allocation of resources. A projected
capital basis and other on cash basis. Statement of fund flow statement will help to allocate
Changes in Financial Position prepared on the resources.
basis of working capital is known as Fund Flow 5. Helps in appraising the use of working
Statement and that on cash basis is known as capital. Fund flow statement tells how
Cash Flow Statement. effectively the fund has been used by the firm.
Fund Flow Statement: it is a statement showing 6. Helps to know the credit worthiness of the
the sources from which funds were obtained and firm. Usually, banks ask for fund flow
how these funds were used. It measures the statements for a number of years to assess
changes that have taken place in the financial the credit worthiness of the firm.
position of a firm between two balance sheet Difference between Fund Flow Statement and
dates. In India it is not compulsory to prepare Income Statement
fund flow statement. Fund Flow Statement Income Statement
Prepared to ascertain Prepared to ascertain
Meaning of fund: in a narrow sense fund means sources and uses of fund profit/loss
cash only. In a broad sense, it includes all Deals with both capital & Deals with revenue
financial resources. In the context of fund flow revenue items only
statement, the term fund means working capital Both sides of fund flow Difference between both
statement are equal sides are profit or loss
(excess of current assets over current liabilities). It’s subsidiary statement It is original statement
Flow means change. Fund means working capital. It is not compulsory It is compulsory under
Companies Act
Thus, fund flow means changes in working
capital. The flow may be inflow or outflow. The
inflow of fund means source of fund and outflow
of fund is application or uses of fund.
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Difference between Fund Flow Statement and 4. Transactions involving a current asset and a
Balance Sheet fixed asset: results in flow of fund. E.g.
Balance sheet Fund Flow Statement purchased machinery for cash.
Static statement Dynamic statement 5. Transactions involving a current asset and a
Shows financial Shows changes in long-term liability: results in flow. E.g. Issued
position on a particular financial position and shares for cash, repayment of long-term loan.
date their causes
6. Transactions involving a current liability and
It the end result of all It is a post balance
accounting operations sheet exercise. a long-term liability: results in flow. E.g.
Compulsory to prepare No legal obligation to creditors settled by issue of debentures.
prepare 7. Transactions involving a current liability and
Matches assets and Matches sources and a fixed asset: results in flow of fund. E.g. fixed
liabilities application of fund. assets purchased for a two months’ credit.
STEPS IN PREPARATION OF FUND FLOW
To solve problems, it is essential to identify every balance STATEMENT
sheet items into current assets, current liabilities, fixed assets
and long-term liabilities. Examples of current liabilities are i. Preparation of schedule of changes in
creditors, bills payable, bank OD, outstanding expenses, working capital
provision for doubtful debts, provision for discount on debtors,
ii. Analysing the changes in non-current
income received in advance, tax payable including provisions,
dividend payable etc. items
iii. Calculation of funds from operation
Permanent liabilities include capital, reserves, profit,
premium, debentures, long term loans, provision for iv. Preparation of fund flow statement
depreciation, tax payable, dividend payable (comes under
current liabilities too).

Current assets include stock, short term investment such as

marketable securities, bills receivable, debtors, advance tax
paid, cash in hand and at bank, prepaid expenses and accrued
income.

Fixed assets include good will, land and building, plant and
machinery, furniture and fittings, vehicles, patents and trade
mark, long term investments, preliminary expenses and loss.

Identification of transactions which cause

flow of fund
As already stated, fund means working capital
and working capital is the difference between
current assets and current liabilities. When
current assets increase, working capital increases
and when current liabilities increase working
capital decreases. To measure flow of fund it is
necessary to identify those transactions which
results in the flow of fund.
1. Transactions involving two current assets: no
flow of fund. E.g. cash collected from debtors
2. Transactions involving two current liabilities:
no flow of fund. E.g. bills payable issued to
creditors
3. Transactions involving one current asset and
one current liability: no flow of fund. E.g. cash
paid to creditors.
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 A decrease in current assets causes a

1. SCHEDULE OF CHANGES IN WORKING decrease in working capital
CAPITAL:  An increase in current liability causes a
decrease in working capital.
The first step in preparing a statement of changes
in financial position-working capital basis-is to
determine the increase or decrease in working
capital. This is done by preparing a separate
statement called ‘Schedule of Changes in Working
Capital’ that shows the change in each working
capital account (current assets and current
liabilities) and its effect on working capital.
Increase in working capital is taken as ‘use of
fund’ and decrease as a ‘source of fund’ in Fund
Flow Statement.

POINTS TO REMEMBER:
Schedule is prepared with help of current assets
and current liabilities appearing in the balance
sheet only. No extra information given should be
considered.

If working cap at the end is more than that of at

the beginning the difference is increase in
working capital and vice versa.

Current assets may be shown either at their gross

values, showing provision against them as
current liability, or at their net values. E.g.
debtors and provision for doubtful debts.

CAUSES OF CHANGES IN WORKING CAPITAL

 An increase in current asset causes an

increase in working capital
 A decrease in current liability causes an
increase in working capital
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Written Down Value Method of preparing

2. ANALYSING CHANGES IN NON-CURRENT fixed asset account
ITEMS When provision for depreciation is not separately
For identifying inflow or outflow of fund on mentioned only fixed asset a/c be prepared to
account of non-current items, ledger accounts ascertain purchase/sale/deprecation/profit or
should be prepared. If adjustments/additional loss on sale etc.
information is not given differences can be Suppose opening value of machinery account
interpreted as follows. shows 100,000 and closing value shows 150,000.
Additional info says that depreciation charged is
Rs.25000.
Machinery a/c
Opening balance 100000 Depreciation 25000
Cash (purchase) 75000 Closing balance 150000
175000 175000
Here purchase of machinery of Rs.75000 should
be shown as an application of fund. Depreciation
charged is to be added back while calculating fund
Decrease in fixed assets can be treated either as from operation.
sale or as depreciation and it will form a source of Original Cost Method of preparing fixed asset
fund. account

REMEMBER: This method is followed when provision for

depreciation is given in the problem.
 Increase in intangible assets like goodwill is
assumed as purchase and decrease as write
off. Such increase is an application of fund
and ‘decrease’ a source.
 Increase in fixed asset is purchase
(application)
 Increase in capital is because of fresh issue
and decrease in redeemable preference
shares is due to redemption. Similarly
Under this method both fixed asset account (to
increase in long term loan is a source and
ascertain purchase/sale/profit or loss on sale) and
decrease an application
provision for depreciation account (to know
 Increase in general reserve means transfer
amount of depreciation charged during the year)
from profit it is added back to current year
should be prepared.
profit to get funds from operation.
At other times, opening and closing values of
 If additional information is given a ledger
provision for depreciation is given as additional
account should be prepared to find out
information too. In this case, these values are
hidden values.
added to opening and closing values of assets
E.g. opening value of plant is Rs.37,000 closing
while preparing fixed asset account.
value Rs.56,000. Additional information states
that depreciation charged is Rs.4000
Plant account
Opening balance 37000 Depreciation 4000
Cash (hidden) 23000 Closing balance 56000
60000 60000

We could trace out that there was an additional

purchase of plant worth Rs.23000.
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3. CALCULATION OF FUND FROM OPERATION

Trading profit is a source of fund. It is income
from operation. It is ascertained as
Net sales xxxx
Less : cost of sales xxx
Less : cash operating expenses xxx xxx
Fund from operation xxxx
Items like depreciation are not deducted as it
does not involve cash outflow.
Fund from operation can also be calculated from
profit (indirectly). Trading profit as shown in
profit & loss a/c includes non-cash (like
depreciation) and non-operating items. These are
to be adjusted to find out exact funds from
operation. If net result is a loss, it will be an
outflow of fund.
There are two methods for calculating fund from
operations indirectly viz., statement method and
profit and loss adjustment account method.
1. Statement method
Under this method calculation is started with net
profit of current year. All non-fund and non-
operating expenses are added and non-fund non-
operating incomes are deducted. Resultant figure
is fund from operation.

2. P/L adjustment account method

Under this method, opening balance of profit and
non-fund and non-operating incomes are
credited and closing balance of profit and non-
fund and non-operating expenses are debited to
adjusted profit and loss account. balancing figure
on credit side is fund from operation (balancing
figure on debit side is fund lost in operation)
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4. PREPARATION OF FUNDFLOW STATEMENT

It is a statement showing sources and application
of fund. It is prepared with the help of fixed
assets and long-term liabilities, capital and
reserves and with the additional information
given after balance sheet

FFO – 37,000
Proposed dividend and taxes are assumed to be
paid during the respective years, unless
otherwise mentioned in question.

Treatment of special items

Proposed dividend appearing in the previous

balance sheet is assumed to be paid during
current year. Proposed dividend of current year
should be added back to profit to find ‘fund from
operation’.
Dividend paid appearing in the adjustment is
added back to profit to find out ‘fund from
operation’. It is also to be shown as an application
of fund.
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Interim dividend is always given under 19. What is capital rationing

adjustment. It should be added back to net profit 20. What is schedule of changes in working
to find fund from operation and should be shown capital
as an application.
Provision for taxation is treated as a non-current
liability. It is added back to profit to find fund
from operation and is shown as an application if
it is paid. According to accounting standard 3
issued by ICAI provision for taxation and proposed
dividend is to be treated as long term liabilities
and should not be shown in schedule of changes in
working capital.
Appreciation of fixed assets: The amount of
appreciation on revaluation of fixed assets, if
credited to P/L, must be deducted from profit to
compute funds from operation.

Limitations of fund flow statement

1. It gives historical information
2. It cannot reveal continuous changes
3. It is not an original statement but only a re-
arrangement of data given in financial
statements
4. Changes in cash are more important than
working capital.
5. It throws light to a part of balance sheet items
i.e., regarding working capital

UNIVERSITY QUESTIONS
1. Define fund
2. What is fund flow statement?
3. Name various sources of fund
4. What is non fund item
5. How would you treat dividend in fund flow
analysis? Provision for dep account
6. How to arrive at fund from operation To machinery 3000 by balance 25000
To balance 40000 by new provision (bf) 18000
7. What you mean by flow of fund
8. What is fund flow analysis?
9. What is application of fund
10. Define statement of changes in financial
position
11. How would you classify assets?
12. What is net working capital
13. Name the components of working capital
14. Explain objectives of fund flow statement
15. What are the various sources of funds?
16. Discuss importance of fund flow statement
17. Discuss causes of changes in working capital
18. Differentiate permanent and variable
working capital
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Provision for dep. On plant account

To machinery 2000 Balance b/d 30000
P/L 7000

Balance c/d 35000

Fund from operation

Net profit 125000
Add dividend 50000
Prel. Exp 1000
Provision (7000 +4000) 11000
Loss on sale 62000