Funds Flow Analysis

1. Definition of Funds Flow Statement

The funds flow statement reveals the sources from where the funds are made available and the purpose for which funds are utilized in an organization. In other words, a statement showing the sources and uses or applications of funds is termed as funds flow statement. 

It facilitates a comparison between the inflow and outflow of funds in two different periods. In addition, it shows the changes in the financial position of an organization by analyzing working capital, operating profit, and changes in long-term assets and liabilities.

In the words of Almond Coleman, “The funds flow statement summarizing the significant financial changes which have occurred in the beginning and end of the accounting period.” 

2. Preparation of Funds Flow Statement

An organization needs to follow some basic rules while preparing funds flow statements. The basic rules help to identify what is to be included in a funds flow statement. It is essential to understand the causes of fund inflow or outflow while preparing funds flow statements.

Generally, following aspects are considered while preparing funds flow statement:

i. Increase in liability would be the inflow of funds; whereas, decrease in liability results in outflow of funds

ii. Increase in assets would be the outflow of funds; whereas, decrease in assets results in inflow of funds

iii. Change in the assets of the same category cannot result in the change of funds. For example- when an organization buys goods in cash, the transaction reduces cash but increases the stock. This transaction does not affect the working capital of the organization because both cash and stock are the part of working capital.

iv. Change in the liability of the same category cannot result in the change of funds. For example- an organization can make payment to the creditors by raising short-term loans. Since, both the creditors and short-term loans are current liabilities; therefore, their effect would be counterbalanced.

Any transaction affecting fixed assets and long-term liabilities does not find place in funds flow statements. For example- a sum of Rs.500,000 is taken as a loan to purchase land. Since land is an asset, this transaction would increase the total assets of the organization. 

However, at the same time, the total liabilities of the organization would also increase because it needs to pay the amount of loan and interest. Therefore, this transaction would not bring any change in the funds flow statement. 

3. Importance of Funds Flow Statement

The importance of funds flow statement is explained in the following points:

i. Helps to understand the changes in assets and their sources that are not readily evident in the income or financial statement of an organization

ii. Shows the application of funds in different spheres of business

iii. Points out the financial strengths and weaknesses of the organization

In most of the cases, funds flow statement and balance sheet are considered similar as both show the financial position of an organization at a particular date. However, these two financial statements differ from each other on the basis of meaning, utility, and purpose of preparation. 

4. Limitations of Funds Flow Statement

Funds flow statement is not free from limitations, which are mentioned in the following points:

i. Ignore the non-financial transactions, such as issue of bonus shares and sweat equity shares.

ii. Requires the preparation of the cash flow statement as the cash position of an organization cannot be determined by the funds flow statement.

iii. Draws its data from the balance sheet and profit and loss account. If these statements are wrong then the funds flow statement would not reveal the true financial position of the organization.