What is a Fund Flow Statement?

A company may earn profits, but where does that money go? Is it used to repay debts, buy new assets, or just held as cash? The fund flow statement answers these questions. It is prepared to highlight the changes in assets, liabilities, and working capital between the dates of two balance sheets. The statement is crucial as it provides information about the movements of funds within a company. 

In this blog, we will explain what a fund flow statement is, its importance, benefits, preparation tips, and how fund flow analysis helps investors and management to make strategic decisions.

Table of Contents:

• What is Fund Flow Statement?
• What is a Funds Flow Statement Analysis?
• What are the Objectives of Fund Flow Statement
• Understanding the Importance of Fund Flow Statement
• Key Components of Fund Flow Statement
• Steps on How to Prepare Fund Flow Statement
• Fund Flow Statement Format
• Key Advantages of Preparing a Fund Flow Statement
• Major Limitations of Fund Flow Statement
• What is the Difference Between Cash Flow Statement and Fund Flow Statement
• How Fund Flow Analysis Empowers Investors and Management
• Conclusion

What is Fund Flow Statement?

In a fund flow statement, the term ‘flow’ means the movement or change of working capital, i.e., an increase or decrease in working capital. Also known as the statement of sources and applications of funds, the statement provides a detailed report of how funds move through various activities.  

It is analyzed to understand a company’s financial position between the two balance sheet dates. In simpler terms, the fund flow statement reveals how funds were obtained (sources) and how they were used (applications) during a particular period, highlighting changes in working capital. The fund flow statement is not mandatory under accounting standards like US GAAP or IFRS. 

However, many organizations still prepare this statement for internal analysis and management reporting purposes. It helps management to understand long-term financial strategies and working capital management, but is not part of formal financial filings. Not just cash, it focuses on movements of funds too, especially changes in working capital. 

Fund Flow Statement Example

If a company raised ₹10 crore by issuing shares, repaid ₹3 crore of debt, and spent ₹5 crore to buy machinery. The fund flow statement records ₹10 crores as a source of funds and ₹3 crores on loan repayment, and ₹5 crore on fixed assets, as application of funds. This helps stakeholders and management see exactly how capital was raised and where it was spent. 

What is a Funds Flow Statement Analysis?

Fund flow statement analysis is an analytical tool that helps track where money is coming in as well as going out of a company during a period of time, and analyze the changes in the stability of a company. It is based mainly on the comparative balance sheets and carries an adjusted profit value (funds from operations), which is calculated on the basis of the income statement. It captures changes in long-term assets, liabilities, and working capital, giving a view of how business activities are financed.

1. Assets

• An increase in fixed assets (like land or machinery) means the company has used funds to purchase them.
• A decrease in fixed assets means the company likely sold assets, resulting in a source of funds. 

2. Liabilities

• An increase in long-term liabilities (like debentures or loans) indicates a source of funds, as the company raised money. 
• A decrease in long-term liabilities means the company repaid its obligations, which is a use of funds. 

3. Working Capital

• An increase in current assets (like receivables or inventory) means more cash gets tied up, so it counts as a use of funds.
• A decrease in current assets, or an increase in current liabilities, releases funds and their source.

What are the Objectives of Fund Flow Statement

A fund flow statement helps people understand how a company’s resources and money change over time. The main objectives of the fund flow statement are as follows:

1. Analyzing the Movement of Funds

The fund flow statement thoroughly monitors where the funds are acquired (e.g., profits, borrowings, or sale of assets) and how the funds are used later (e.g., acquiring assets, repaying debt, or increasing working capital). It shows the effect of these fund flows on the working capital of the company, helping assess whether the business is building or losing working capital.

2. To Evaluate Financial Health of a Company

The statement assists in evaluating the financial stability of the company by examining the movement of funds. It also reveals the capability of the company to meet obligations and finance further expansion. It helps management to identify areas where the company is doing well in generating funds and where it might be facing challenges, allowing them to improve.

3. Assisting in Financial Planning

The fund flow statement plays a very important role in making sound investment, financing, and capital budgeting decisions. With the historical analysis of fund flows, companies are able to anticipate future requirements of cash requirements and develop proper financial strategies.

4. Building Accountability Through Transparency 

It provides a clear image of what financial activity the company does, fostering transparency and accountability in the management of funds. This transparency equips the stakeholders to make well-informed decisions about the financial health of the company.

Understanding the Importance of Fund Flow Statement

It is a powerful analytical tool that provides valuable information about a company’s financial health. 

Here are some of the ways a fund flow statement can be useful:

1. Explaining Financial Changes

Both the balance sheet and the profit and loss statements show current and previous data, but do not explain why financial fluctuations happen. The fund flow statement thoroughly describes the reasons behind fluctuations in current assets and liabilities, offering a clearer picture of how profit is converted into cash and highlighting any liquidity risk.

2. Guiding Strategic Financial Planning

It functions as a financial guide, helping management predict potential financial struggles and create plans to minimize losses. The statement is important for long-term financial planning, decision-making, and performance evaluation of operations.

3. Determining Liquidity Issues

A company earning profits doesn’t indicate it is in a good financial position. The fund flow statement helps identify liquidity issues that may not be obvious from profit figures alone.

4. Improving Financial Control

It offers structure for monitoring financial performance, assessing potential risks, and taking the correct measures to boost profitability and efficiency.

5. Measuring Fund Efficiency

Management assesses whether working capital is being used efficiently and if it is sufficient for the business’s operations with the help of the fund flow statement. These insights help management in making wise decisions on dividend policies and other financial strategies.

6. Financial Clarity for Investors

With the help of the fund flow statement, investors measure how well the company handles its funds and its overall capital allocation. Further, it also helps in estimating the creditworthiness and future funding needs of a firm.

Key Components of Fund Flow Statement

A funds flow statement is also referred to as a statement of sources and application of funds. It explains how a firm operates on its finances. 

It can be divided into two main components:

1. Sources of Funds

This section highlights where the funds come from:

1. Funds from Operations: It is the cash generated from the core operating activities of the business.

2. Issue of Shares and Debentures: The money raised from issuing shares or debentures is recorded here. However, as bonus issues of convertible debentures do not involve an immediate cash inflow, they are not included.

3. Raising of Long-Term Loans: It covers funds acquired from long-term loans and borrowings, excluding short-term loans, detailed in the working capital statement.

4. Sale of Fixed Assets: Cash received from selling fixed assets is recorded as a source of funds.

5. Decrease in Working Capital: This figure ties back to the change in net working capital.

2. Application of Funds

This section describes how the funds are used:

1. Purchase of Investments and Fixed Assets: It involves cash payments for obtaining investments and fixed assets. However, transactions involving shares or debentures in exchange for assets are not included here, as they do not involve cash outflows.

2. Repayment of Loans and Redemption of Debentures: Includes debenture redemption payments or repayment of loans, including any premium but excluding discounts.

3. Payment of Dividends and Tax: Here, cash payments for dividends and taxes are recorded. From current liabilities, provisions are removed and added back in the calculation of funds from operations.

4. Increase in Working Capital: The increase in working capital balances the total, ensuring both inflow and outflow figures match.

Knowing these components will help you have a better idea of what is happening to the finances of your company. The statement helps you to know the areas through which finances are being generated and used. 

Steps on How to Prepare Fund Flow Statement

To prepare a fund flow statement, follow these three main steps:

Step 1: Prepare a Statement of Changes in Working Capital

First,  start by comparing the current assets and liabilities from two balance sheets (previous and current year). Working capital increases if current assets exceed current liabilities. If current liabilities exceed current assets, working capital decreases. 

This helps you understand how the short-term liquidity of the company has changed. Remember, the difference between current assets and current liabilities determines the change in net working capital.

Step 2: Calculate Fund from Operations

After calculating the changes in working capital, you need to prepare an adjusted Profit & Loss Account to find out how much money the business generated from its core operations. First, mention the net profit on the credit side. 

Then add back non-cash expenses such as amortization and depreciation. Subtract any profits from the sale of assets or investments since those are not regular business activities. The result is the actual funds generated from daily business operations.

Step 3: Identify Sources and Applications of Funds

List all the sources and applications (uses), using the balance sheet. Sources of funds include taking loans, issuing shares, or selling fixed assets. On the other hand, applications of funds include buying fixed assets, paying dividends, or repaying loans. 

Also, add the funds from operations and net change in working capital in the final fund flow statement. 

Fund Flow Statement Format

Before preparing a final fund flow statement, you first need to prepare a changes in working capital statement and a profit and loss adjusted account. After this, you can prepare the fund flow statement, which includes two sections: sources of funds and applications of funds. 

Here is the detailed fund flow statement format:

Key Advantages of Preparing a Fund Flow Statement

A comprehensive analysis of the fund flow statement can provide significant insight into a business or organization, considering its advantages. Let’s take a look at the advantages of the fund flow statement:

1. Highlights Changes in Share Capital 

The fund flow statement shows changes in share capital, such as buybacks or new issues. It helps track how the company’s capital structure changes over time, which can affect shareholder value.

2. Shows Financial Position

A fund flow statement gives a detailed view of the company’s financial position by showing changes in working capital and funds between two dates. This helps stakeholders understand the liquidity and funding patterns of the company.  

3. Indicates Financial Performance

The fund flow statement does not reveal profit and loss directly, but it uses adjusted profits to compute funds generated from operations. This allows stakeholders to assess the operational efficiency and financial performance of the company.

4. Records Changes in Share Premium

The premium amount, which is the difference between the issue price and the face value, is recorded as a source of funds in the fund flow statement when a company issues shares at a premium. This shows adjustments related to equity financing. 

5. Reports Long-Term Borrowings

It specifies any new long-term borrowings and repayments, including funds raised through debentures. This helps in providing insights into how the company finances its long-term investments and manages debt.

6. Highlights Changes in Working Capital 

The statement reveals changes in working capital. It shows how the company manages its short-term resources to meet immediate obligations.

7. Helps in Future Planning

By performing a fund flow analysis, management can predict future financial requirements and struggles. The analysis highlights trends and financial movements, helping management to do strategic planning and address potential financial issues before they happen.

Major Limitations of Fund Flow Statement

Despite the advantages of the fund flow statement to the company, it suffers from various limitations as well. Here are the major limitations of the fund flow statement:

1. Lacks Detailed Explanation

The fund flow statement lacks thorough explanations of individual transactions. The analysis is not comprehensive and does not provide a detailed view of specific transactions within the fund categories. 

2. Subjectivity in Classifications

The activities can be classified as operating, investing, and financing, which might be subjective and hence might be misinterpreted. Moreover, variation of accounting practices and interpretations could also affect the consistency of fund flow classifications.

3. Ineffective for Liquidity

While working capital is crucial, cash flow offers a clearer picture of liquidity, making it a more practical indicator for financial forecasting. Therefore, the use of the fund flow statement is not the best tool for forecasting cash needs and assessing liquidity.

4. Lacks Originality

The fund flow statement can be said to be lacking originality since the fund flow statement is just the rearrangement of items in the financial statements for two accounting periods. Due to this reason, the preparation of fund flow statements is not done by many companies.

5. Based on Past Performance

This statement does not provide much information about the present and the future costs of the company, but only shows how the company has been doing so far in its previous year. Therefore, it fails to show a real picture of the profitability of the enterprise. The estimated fund flow statement is not very precise either.

What is the Difference Between Cash Flow Statement and Fund Flow Statement

Although both the cash flow statement and fund flow statement offer insights into financial activities, their primary focus and scope differ significantly. 

Below are the key differences between cash flow and fund flow statement:

How Fund Flow Analysis Empowers Investors and Management

If you want to know how efficiently a business handles its capital, fund flow analysis is a valuable tool for answering this question. By looking at where a company generates its funds from and how it applies them, investors can:

• Creditworthiness: Good management and balance of flow of funds represent the financial discipline and stability, which are important signs of a company’s ability to pay its debts.

• Evaluate Smart Investment: It will give a better judgment on how sustainable a company will be financially and have the potential to expand without having to depend largely on external finances, and it is simpler to determine whether an investment is safe or not.

• Measure Management Effectiveness: The analysis exposes the effectiveness of how the management is using its resources, maximizing capital investments, and creating viable returns.

This analysis is also useful to an organization, outside of the external stakeholders. It provides them with insightful data that would enable them to make effective decisions in order to optimize the use of resources, proper capital budgeting, and profit maximization.

Conclusion

To sum up, the fund flow statement is the backbone of financial analysis, which gives information about the cash flow of a company and its financial position. The knowledge about its presence and implications can help businesses and investors make more informed decisions and explore the complexity of the financial environment with a sense of confidence. With the knowledge of such a statement, funds can be converted into working capital quite successfully, resources can be allocated more adequately, and overall financial stability can be improved.

Fund Flow Statement – FAQs