Last Updated on Feb 10, 2022 by Ayushi Mishra
Funds are essential to run and grow a business. During a financial year, a business undertakes various financial transactions wherein funds flow into the business as well as out of it. To track and draw an understanding of the amount of funds that have moved in and out between two financial years, a fund flow statement is prepared.
This article covers:
- What is a fund flow statement?
- Objectives of preparing funds flow statement
- How is a fund flow statement prepared?
- Format of funds flow statement
- Uses of funds flow statement
- Limitations of fund flow statement
What is a fund flow statement?
A fund flow statement outlines the changes in the financial position of a company between two financial years. It takes into account the balance sheets of two financial years and then assesses how the funds have flown into and out of the business in the two years. The fund flow statement uses the assets and liabilities listed on the balance sheet to analyse the movement of funds. As such, it helps in ascertaining the changes in the company’s working capital between two financial years.
Objectives of preparing funds flow statement
While the profit and loss account and balance sheet are the important financial documents of a business, they do not explain the movement of funds. A profit and loss account shows the income and expenses of the business and the net profit or loss. A balance sheet, on the other hand, shows the statement of assets and liabilities.
A fund flow statement, meantime, shows:
- From where the funds have come into the business, that is the sources of funds
- Where have the funds gone, that is the application of funds
The objective of preparing a fund flow statement is, therefore, to gauge these sources and the application of funds.
How is a fund flow statement prepared?
Preparation of the fund flow statement is not a lone affair. The statement is preceded by two other statements which are as follows:
- Statement of changes in working capital
- Computation of funds from operation
Once these two statements are prepared, the next step is the preparation of the fund flow statement.
Format of funds flow statement
Here’s how a fund flow statement usually looks:
|Sources of funds||Amount||Application of funds||Amount|
|Issue of fresh capital||XXX||Purchase of assets like building, plant and machinery, equipment, investments||XXX|
|New debt financing through loans or debentures||XXX||Repayment of existing liabilities like loan||XXX|
|Funds generated from business operations||XXX||Redemption of debentures||XXX|
|Sale of assets||XXX||Payment of dividends or taxes||XXX|
|Balancing figure (aggregate amount of application of funds – aggregate amount of sources of funds)||XXX||Balancing figure (aggregate amount of sources of funds – aggregate amount of application of funds)||XXX|
The total of both sides of the fund flow statement must match each other. This matching is done by entering a balancing figure on either side.
- If the funds generated is higher than funds used, the balancing figure is listed on the ‘Application’ side. This shows a positive inflow of funds and an increase in the working capital amount.
- If the funds used is higher than the funds generated, the balancing figure is placed on the ‘Source’ side. This shows a higher outflow of funds from the business and reduces the working capital amount.
Uses of funds flow statement
The fund flow statement can be used for multiple purposes:
Fund flow analysis helps companies understand if they have a shortage or excess liquidity. Even if the company generates a profit, if the funds used are higher than the funds sourced, the company could face a liquidity crunch which might prove challenging in a bad business cycle.
Usage of funds
The fund flow statement helps the management understand how the funds are being used. This can give insights into whether short-term funds are being put to long-term use or not, an area that needs to be studied for sound financial management.
Answers important questions
A fund flow statement answers various relevant questions regarding funds. For example, using the statement, the following questions can be easily answered:
- How did the working capital change?
- How were fixed assets financed?
- Did the company raise new capital or seek debt financing?
- How were the net profits used?
Identifying problem areas
The statement can help analysts zero in on the problem areas that are hampering the liquidity of the business. By studying the sources and uses of funds, the financial sufficiency, and factors affecting it, can be easily pinpointed.
Finalising the dividend policy
By assessing the funds at the disposal of the company, the amount of dividend to be distributed and the profits to be retained can be determined.
Helps investors and lenders
When businesses seek finance, lenders check the fund flow statement to assess the usage of the funds and whether such usage is optimal or not. Investors can also make informed investment decisions by studying the financial efficiency of the business through fund flow analysis.
Limitations of fund flow statement
Though the fund flow statement has varied uses and is an important financial statement, there are some limitations to it as well. These include the following:
- The statement records the movement of funds on a historical basis. As such, it does not present an accurate present-day picture of the business.
- The statement focuses only on the movement of funds. The movement of cash is ignored which gives a skewed financial picture of the business.
- The fund flow statement cannot give the whole financial view of the business independently. It has to be used with other financial statements for a complete understanding of business finances.
As an investor, understand a fund flow statement and assess the statement of the company into which you want to invest in. The statement can give you useful insights into how the company is utilizing its funds and help you make the right investment decision.