What is a Fund Flow Statement & How is it Prepared?
A fund flow statement tracks the movement of funds or assets in and out of a company, typically on a monthly or quarterly basis. It highlights changes in a company’s financial position by comparing two balance sheets, revealing the sources and uses of funds over a specific period. This article will analyse the concept of fund flow statements and how they are prepared. It will also discuss the objectives, components and limitations of a fund flow statement, to form a comprehensive financial understanding on the subject.
What is a Fund Flow Statement?
A fund flow statement is a financial document that compares a company’s balance sheets from two consecutive years. It tracks how funds have moved from the previous year to the current year, focusing on the sources and uses of funds during the accounting period. This analysis helps investors understand the impact on the company’s working capital.
Typically, preparing a fund flow statement involves analysing fund flows to manage finances effectively and optimise fund utilisation. This document shows changes in working capital by comparing inflows and outflows, helping to reveal the reasons behind shifts in financial metrics and aiding in evaluating a company’s financial progress.
Effective management of working capital and funding is crucial for any business. A fund flow statement helps identify where funds are coming from and how they are used. This statement provides insights into a company’s financing activities, investment decisions, and liquidity.
What is a Funds Flow Statement Analysis?
A fund flow statement analysis helps track changes in a company’s financial situation by evaluating various financial statements, including:
- Balance Sheet: Summarises assets, liabilities, and capital accounts, showing their balances at a specific time. An increase in assets typically indicates new acquisitions funded by the company, which may lead to future cash inflows. Conversely, a decrease in assets often suggests that the company has sold assets to maintain liquidity.
- Profit and Loss Statement (Income Statement): The profit and loss statement details revenue, costs, and profit or loss for a specific period.
- Cash Flow Statement: This statement tracks cash inflows and outflows from operating, investing, and financing activities over a defined period. It closely resembles the fund flow statement. Increases in liabilities on the fund flow statement suggest new funds that will require repayment, while decreases indicate that existing obligations have been settled.
A balance sheet shows current assets, liabilities, and equity, but it doesn’t reveal the source or use of funds. The funds flow analysis statement compares two accounting periods to reveal changes from one year to the next, providing a clearer picture of how funds are sourced and utilised.
How is a Fund Flow Statement Useful?
Here are a few ways a fund flow statement can be useful:
- Clarifying Financial Changes: While profit and loss statements and balance sheets show current and previous figures, they do not explain why financial movements occur. The funds flow statement reveals the reasons behind changes in current assets and liabilities, offering a clearer picture of how profit translates into cash and highlighting any liquidity issues.
- Identifying Liquidity Issues: Even profitable companies can face cash shortages. The fundsflow statement helps identify these issues, which might affect the company’s ability to distribute dividends despite having significant profits.
- Strategic Financial Planning: This statement acts as a financial guide, helping management anticipate potential financial challenges and develop strategies to mitigate significant losses. It is crucial for long-term financial planning and operational performance analysis.
- Assessing Creditworthiness: Lenders often review the fund flow statement over several years to evaluate a company’s creditworthiness before granting loans. It demonstrates the company’s ability to manage its funds effectively, which is critical for securing financing.
- Evaluating Working Capital Efficiency: The fund flow statement aids management in assessing whether working capital is being used efficiently and if it is adequate for the business’s needs. This information supports decisions on dividend policies and other financial strategies.
- Supporting Investment Decisions: Investors use the fund flow statement to gauge how well the company manages its funds and its overall financial stability. It also helps in evaluating the firm’s creditworthiness and future funding requirements.
Components of a Fund Flow Statement
A funds flow statement is also known as the statement of sources and application of funds. It details how a company manages its funds. It can be broken down into two main components:
Sources of Funds
This section shows where funds come from:
- Issue of Shares and Debentures: This includes money raised from issuing shares or debentures. However, bonus issues of convertible debentures are not included as they do not involve an immediate cash inflow.
- Long-Term Loans: This section covers funds obtained from long-term loans and borrowings, excluding short-term loans, which are detailed in the working capital statement.
- Sale of Fixed Assets: This refers to the cash received from selling fixed assets.
- Funds from Operations: This is the cash generated from the business’s core operating activities, as calculated in the fund flow statement.
- Decrease in Working Capital: This figure balances the fund flow statement and corresponds with changes in working capital.
Applications of Funds
This section outlines how funds are used:
- Purchase of Fixed Assets and Investments: This includes cash payments for acquiring fixed assets and investments. Transactions involving shares or debentures in exchange for assets are not recorded here, as they do not involve cash outflows.
- Redemption of Debentures and Repayment of Loans: Payments made to redeem debentures or repay loans, including any premium but excluding discounts, are included in this section.
- Payment of Dividends and Tax: Cash payments for dividends and taxes are recorded here. Provisions are adjusted by removing them from current liabilities and adding them back in the calculation of funds from operations.
- Increase in Working Capital: This figure represents the balancing item in the fund flow statement and aligns with changes in working capital.
How to Prepare a Fund Flow Statement?
Here is a step by step guide on the preparation of fund flow statements:
Schedule Changes in Working Capital
Assess changes in current assets and current liabilities to determine net changes in working capital. The difference between net current assets and net current liabilities reveals the net increase or decrease in working capital.
- Increase in Working Capital: When long-term funds exceed their application, it indicates an increase in working capital. These funds can be used for short-term needs, such as repaying short-term loans or paying dividends. This increase will be listed under ‘Application of Funds’ in the Fund Flow Statement.
- Decrease in Working Capital: If a company uses available funds for working capital but lacks long-term sources, it results in a decrease in working capital. This decrease will be shown under ‘Source of Funds’ in the Fund Flow Statement.
Adjusted Profit & Loss Account
Calculate Funds from Operations by adjusting the net profit for non-cash expenses such as depreciation and amortisation. Subtract any profit from the sale of investments or fixed assets to determine the actual funds generated from operating activities.
Identify Sources and Applications of Funds
Determine the inflows (Sources of Funds) and outflows (Applications of Funds) from the balance sheet, as well as net changes in working capital and funds from operations, to complete the fund flow statement.
Example of a Fund Flow Statement
In this fund flow statement example, we explore the fund flow statement of Company ABC Ltd. for the year ending 31st March 2024. This statement outlines the sources and applications of funds, providing a snapshot of how the company managed its financial resources over the period.
Sources of Funds
- Increase in Long-Term Liabilities: Company ABC Ltd. raised Rs. 2,00,000 through long-term borrowings.
- Proceeds from Issuance of Shares: The company issued shares and received Rs. 1,50,000.
- Funds from Operations: Calculated from the adjusted profit and loss account, which is Rs. 3,00,000.
| Sources of Funds | Amount (Rs.) |
| Increase in Long-Term Liabilities | 2,00,000 |
| Proceeds from Issuance of Shares | 1,50,000 |
| Funds from Operations | 3,00,000 |
| Total Sources of Funds | 6,50,000 |
Applications of Funds
- Purchase of Fixed Assets: Rs. 2,50,000 was spent on acquiring new fixed assets.
- Repayment of Long-Term Debt: The company repaid Rs. 1,00,000 of its long-term debt.
- Payment of Dividends: Rs. 50,000 was paid out as dividends.
- Increase in Working Capital: Additional working capital was increased by Rs. 1,50,000.
- Net Increase in Cash: The net increase in cash is the difference between total sources and applications of funds, which is Rs. 1,00,000.
| Applications of Funds | Amount (Rs.) |
| Purchase of Fixed Assets | 2,50,000 |
| Repayment of Long-Term Debt | 1,00,000 |
| Payment of Dividends | 50,000 |
| Increase in Working Capital | 1,50,000 |
| Total Applications of Funds | 5,50,000 |
| Net Increase in Cash | 1,00,000 |
Fundamentals Chart
| Fundamental | Amount (Rs.) |
| Net Profit | 4,00,000 |
| Depreciation & Amortisation | 50,000 |
| Profit on Sale of Assets | -20,000 |
| Funds from Operations | 3,00,000 |
| Increase in Working Capital | -1,50,000 |
| Net Cash from Operations | 1,50,000 |
How to Interpret a Fund Flow Statement?
Assessing Financial Health
A fund flow statement offers valuable insights into the financial health of an asset class, sector, or company. For example, if a sector experiences significant net inflows, it may signal a strong industry outlook. Conversely, prolonged net outflows from a specific asset class, like bonds, could indicate potential weaknesses. For individual companies, high net outflows might suggest challenges in managing working capital effectively. However, irregular fund movements should not be used to make definitive conclusions about financial health.
Understanding Investor and Customer Sentiment
Investor sentiment can be gauged through fund flow trends. A decline in cash inflows and an increase in outflows from equities might reflect broader market pessimism. In contrast, rising net inflows into debt mutual funds could indicate a shift towards fixed-income investments. In a business setting, increased net inflows often point to positive customer sentiment towards new products or innovations, while decreasing inflows might suggest waning interest.
Evaluating Demand
Fund flow statements can help assess demand for underlying assets. For instance, growing net inflows into mutual funds or ETFs typically suggest increased demand for their assets. High net outflows, however, may indicate lower demand. Irregular inflows or outflows might also signal transactions such as asset purchases or sales.
Insight into Working Capital
An increase in working capital, shown by higher current assets or reduced current liabilities, generally indicates improved liquidity. This allows a company to better manage its working capital needs, pay dividends, or reduce short-term debt. Conversely, a working capital deficit, marked by fewer long-term funds and higher fund applications, might necessitate additional borrowing.
Objectives of a Fund Flow Statement
Here are a few key objectives and uses of funds flow statements:
- Analysing Operating Performance: The balance sheet offers a snapshot of the company’s finances at a specific moment. On the other hand, the fund flow statement delves deeper into the movement of funds. This detailed analysis aids in better financial planning and understanding of the company’s operations.
- Tracking Financial Position Changes: This statement clarifies why changes occurred in assets, liabilities, or equity capital by comparing balance sheets from different periods. This comparison helps in understanding shifts in the company’s financial standing.
- Resource Allocation: The fund flow statement provides insights into efficient resource allocation. It details how resources are obtained, whether from internal sources or external financing, thus aiding in better management of funds.
- Assessing Financial Stability: It helps evaluate the company’s financial stability by highlighting its strengths and weaknesses, which are useful for both internal and external users of the financial statements.
- Guiding Future Decisions: The statement records historical changes in working capital and assets. This information is useful for making future financial decisions and budgeting.
Limitations of a Fund Flow Statement
Here are a few limitations of funds flow statements:
- Scope Limitation: The fund flow statement focuses solely on the movement of funds. It does not encompass other financial metrics included in the balance sheet or profit and loss account. This narrow focus means that it provides only a partial view of a company’s financial health. To gain a comprehensive understanding, the fund flow statement should be analysed in conjunction with the balance sheet and profit and loss account.
- Cash Position: This statement does not reflect the company’s cash position, which is a crucial aspect of financial analysis. To assess cash flow and liquidity, a separate cash flow statement is necessary. The fund flow statement alone does not provide insights into how well a company manages its cash resources.
- Historical Nature: The fund flow statement is based on historical data. This can limit its ability to accurately represent the current financial situation of a business. This historical focus may not fully capture present-day financial realities, making it less effective for real-time financial analysis.
- Lack of New Numerical Value: The statement does not introduce new financial data but instead rearranges existing information to highlight issues with fund management. As a result, it does not add any new numerical insights into the company’s financial position but rather offers a different perspective on the available data.
Benefits of Preparing a Fund Flow Statement
Here are a few benefits demonstrating the significance of fund flow statements:
Shows Financial Position
A fund flow statement provides a clear picture of a company’s financial status by tracking changes in profits. This helps stakeholders understand how well the company is performing financially and offers a snapshot of its overall health, benefiting shareholders who are keen to gauge the company’s profitability.
Highlights Share Capital Changes
The statement reveals any adjustments in share capital, making it easier to see if there have been increases or decreases in equity. This information is crucial for understanding how the company’s capital structure evolves over time, reflecting changes that might impact shareholder value.
Tracks Share Premium Fluctuations
By showing fluctuations in share premiums, the fund flow statement provides insight into financial adjustments related to share issuance. It highlights when premiums increase, such as during new share issues, or decreases, such as from reductions in preferential shares or debentures.
Reveals Profit or Loss
The statement clearly identifies whether the company is making a profit or incurring a loss from its operations. This transparency allows stakeholders to assess the company’s operational efficiency and financial performance, providing a straightforward measure of profitability.
Displays Long-Term Borrowings
It details any additional long-term borrowings, including funds raised through debenture issuance. This information is essential for understanding how the company finances its long-term investments and manages its debt obligations.
Shows Working Capital Changes
The statement indicates changes in working capital, particularly when current liabilities exceed current assets. This provides insight into the company’s short-term financial health and its ability to meet immediate obligations.
Guides Future Planning
A fund flow statement helps management anticipate future financial needs and challenges by highlighting trends and financial movements. This foresight aids in strategic planning and helps in addressing potential financial issues before they arise.
Informs Dividend Policy
It provides valuable information that can influence dividend decisions. Even if a company reports high profits, the statement can show whether there is sufficient cash flow to support dividend payments. This aids in the formulation of a sound dividend policy.
Difference Between Cash Flow Statement and Fund Flow Statement
| Aspect | Fund Flow Statement | Cash Flow Statement |
| Purpose | Analyses changes in working capital between balance sheets | Tracks cash inflows and outflows within a specific period |
| Focus | Focuses on sources and uses of funds, including working capital changes | Focuses on actual cash transactions, including operating, investing, and financing activities |
| Components | Includes financing activities, investments, and operational changes | Includes cash flows from operating, investing, and financing activities |
| Time Frame | Can be prepared for various periods, often comparing balance sheets at different times | Typically prepared for specific periods like monthly, quarterly, or annually |
| Scope of Analysis | Highlights changes in the overall financial structure and liquidity | Emphasises cash generation and usage, providing a detailed view of cash management |
| Reporting Basis | Based on the difference in working capital, showing how funds have been raised and used | Based on actual cash movements, detailing cash receipts and payments |
| Usefulness | Helps in understanding financial health and planning for future funding needs | Useful for evaluating a company’s ability to generate cash and manage cash flow effectively |
| Decision-Making Support | Supports decision-making related to financing and investment strategies | Provides insights into day-to-day cash operations and financial stability |
To Wrap It Up…
Fund flow statements are useful for evaluating a company’s financial performance and cash management. They can be prepared monthly, quarterly, or annually. These statements can be valuable for investors, creditors, management, and financial analysts in making informed decisions. However, it focuses only on funding items and should not be the sole basis for all financial decisions. Investors can study a fund flow statement and other financial statements to form a more wholesome understanding of the company’s financial performance.
Frequently Asked Questions About Fund Flow Statements
Cash flow tracks a company’s actual cash inflows and outflows, including cash and cash equivalents. Fund flow, on the other hand, reflects the net movement of working capital. It also details how cash moves in and out of the business.
Net Present Value (NPV) helps evaluate if an investment, project, or business will be profitable. It calculates the value of all future cash flows, adjusted to their current worth, to assess potential profitability.
Flow of Funds (FOF) are financial accounts that track the movement of money between different sectors of an economy.
The main aim of preparing a fund flow statement is to cite the reasons for changes in the liabilities, assets, or equity capital. It is done by comparing the two balance sheets for different accounting periods. The balance sheet gives a static view of the company’s financial position.
The balance sheet shows an organisation’s financial position at a specific time. In contrast, the fund flow statement tracks changes in this position over a period of time. Combined, these documents can provide a complete overview of the company’s position regarding liquidity and solvency.
