What is a Fund Flow Statement?
A Fund Flow Statement is a financial report that depicts the profitability and financial position of a company. The statement provides knowledge about a firm’s liquidity and also solvency on the basis of the flow of funds to a company.
The cash movements in and out of a range of financial assets are reflected in the fund flows. As a result, the Fund Flow Statement discloses all types of inflows and outflows that a firm has experienced.
A fund flow statement requires a Profit & Loss Statement and two consecutive balance sheets of the company. An in-depth analysis of two years’ balance sheets reflects the actual inflow and outflow of the funds from the previous financial year to the current financial year. Moreover, it’s a summary of assets, liabilities and equities that impact working capital throughout the course of a financial year.
It is also commonly called a ‘Statement of Sources and Uses of Funds.’
The two purposes of a fund flow statement are accounting and investing. Investors widely rely on a fund flow statement to analyse an investment option. The statement compares the inflows and outflows of funds during a particular year. Therefore, this comparative statement can help analyse the movement of funds between two consecutive years.
Objectives of Preparing a Fund Flow Statement
Following are the objectives of preparing a fund flow statement:
Explains the Changes in the Financial Position
A fund flow statement discloses the cause of changes in the assets, liabilities and equity between two consecutive years. It shows changes in a company’s financial position. Moreover, it identifies the different methods of obtaining and using the funds.
Analysing the Operational Position
A balance sheet shows the financial position of a firm, while a profit and loss statement shows the income statement. However, neither show the operation position of a company. A highly profitable company may not be able to pay off its liabilities due to a shortage of cash. The fund flow statement explains both – reasons for variations in different assets, liabilities, and capital accounts and their impact on the company’s liquidity position.
Assists in the Allocation of Resources
The statement provides information regarding the internal and external sources of financing. Also, the purpose of a fund flow statement is to give information on the efficient and effective use of limited resources. Furthermore, it gives the data regarding unbalanced funds. A company may better manage its finances in both the short and long term using this information.
Evaluate the Financial Position
Internal and external consumers of financial statements require a fund flow statement in order to analyse the firm’s strengths and weaknesses. Hence through this statement users can analyse and evaluate the firm’s financial situation.
Acts as a Future Guide
Fund flow statements explain the changes in net assets and capital that help the management forecast the fund flow statement. Such forecasted fund flow statements aid in determining the requirement and also identifying alternative financing sources.
Components of a Fund Flow Statement
A fund flow statement broadly gives information about the following:
- Sources of funds: It basically shows where the company has gotten the funds from. It can be from the owners or outsiders.
- Application of funds: It shows how the company uses the funds, mainly focusing on fixed assets and current assets.
How is the Fund Flow Statement Prepared?
A fund flow statement can be prepared in three steps. The following statements have to be prepared to complete the fund flow statement:
- Statement of changes in working capital
- Statement showing funds from operations
- Fund flow statement
Statement of Changes in Working Capital
Preparing this statement is the first step towards preparing a fund flow statement. In this statement, the company account for changes in working capital. Working capital is the net of current assets and current liabilities and it is calculated by subtracting current liabilities from current assets. Positive working capital is a good sign for any business. This statement shows an increase or decrease in working capital.
- Increase in working capital: An increase in the working capital can indicate an increase in current assets or a decrease in current liabilities. For example, extending credit which might shoot up the receivables or paying off short term loans and bills payable, which can reduce the current liabilities.
- Decrease in working capital: A decrease in the working capital can be due to a decrease in revenue, or unable to encash accounts receivable, or even mismanagement of inventory.
Statement Showing Funds from Operations
The next step is to estimate the funds from operations. It includes the funds used and generated from operating activities of the business and not from investing and financing activities. Here some adjustments that the company makes to the net profit for the year. They add back non-cash expenses like depreciation and amortisation. They subtract any profit from the sale of investments and fixed assets to arrive at the actual fund generated from operating activities.
Statement of Fund Flow
This is the final step that will calculate the flow of funds. This statement clearly shows the sources and application of funds. The different sources and applications of funds have to be clearly mentioned.
Sources of Funds
The line items under sources of funds include:
- Issue of shares and debentures: Only the issue of shares or debentures come under this head. Any bonus issue of convertible debentures do not come here as there is no cash inflow.
- Long-term loans: Only long-term loans and borrowings come under this section. This is becuase the short-term loans are already presnet in the working capital statement.
- Sale of fixed assets: The amount received from the buyer of the fixed assets.
- Funds from operations: It is the funds from the operating activities of the business . It is computed in the previous step in the statement showing funds from operations.
- Decrease in working capital: This is basically the balancing figure of the fund flow statement and will match the amount in the change in the working capital statement.
Application of Funds
The line items under application of funds include:
- Purchase of fixed assets and investments: Only cash payments made for purchasing assets and investments have to be recorded. Also, purchases made in exchange for shares or debentures should not be recorded as there is no cash outflow.
- Redemption of debentures and repayment of loans: Payment made against debentures or loans, including premium and excluding discount, must be considered as the application of funds.
- Payment of dividends and tax: Payment of dividends and tax is the application of funds. However, the provisions are excluded from current liabilities and added back to determine funds from operations.
- Increase in working capital: This is basically the balancing figure of the fund flow statement and will match with the amount in a change in the working capital statement.
How to Interpret a Fund Flow Statement w.r.t Investment in Mutual Funds?
Determination of Financial Health
The fund flow statement helps in determining the health of an asset class, sector, business or market as a whole. For example, suppose stocks from the financial sector have a significant net inflow. In that case, it may indicate that the industry is in good shape. On the other hand, if a single asset class, such as bonds, experience a significant net outflow over a long period of time, it may indicate that fixed-income instruments are in bad condition.
Similarly, for companies, a fund flow statement indicates the financial health of the company. For example, suppose a company is witnessing a high net outflow of funds. In that case, it may be indicative of its inefficiency to manage working capital requirements effectively.
However, it is important to note that irregular movements in net inflow and outflow do not indicate anything substantial to conclude anything about a company’s financial health.
Consideration of Investor and Customer Sentiment
The fund flow statement helps analyse investor sentiment by monitoring the fund flow in asset classes, sectors or also markets. For example, suppose equities see a decline in cash inflow and a rise in cash outflow. In that case, this may suggest lower investments and more redemptions. This scenario may be interpreted as a classic example of broad market pessimism for market-linked assets.
The fund flow statement in a business context may indicate the customer sentiments towards a new product, innovative processes, and also a shift in consumer preferences. Moreover, an increase in net inflow indicates a positive sentiment and vice versa.
Determination of Demand
The fund flow statement can also help to interpret the demand for an underlying asset. For instance, if a mutual fund or an ETF witnesses an increase in net inflows, it may imply the fund managers have more money at their disposal to invest. As a result, the demand for the underlying asset increases. On the contrary, if the fund is witnessing high net outflows, it may imply less monetary support to the fund manager for investments. And a decreased demand for the underlying asset.
Furthermore, these statements may also identify any irregular inflows or outflows. For example, a company might have purchased an asset or sold an existing asset.
Difference Between a Cash Flow Statement and a Fund Flow Statement
Following are the differences between cash flow statement and fund flow statement:
|Point of Difference||Cash Flow Statement||Fund Flow Statement|
|Basis of Analysis||The cash flow statement is based only on cash and is one of the elements of working capital.||The fund flow statement is based on a broader concept – working capital.|
|Source||Shows the opening balance of cash and reaches the closing balance after accounting for inflows and outflows.||Determines the various inflows and outflows of funds.|
|Usage||Useful in analysing the short term effects of liquidity of the business.||Useful in analysing long term financial health.|
|Changes in Working Capital||Changes in current assets and current liabilities are part of the cash flow statement itself.||The changes in current assets and current liabilities are part of the schedule of changes in working capital.|
|Components||Cash flow from operating activities, Cash flow from investing activities and Cash flow from financing activities||Statement of changes in working capital, and Statement of funds from operations|
|Result||Determines the factors that cause changes in cash.||Determines the factors that cause changes in net working capital.|
|Principal of Accounting||CFS data obtained on an accrual basis are converted into a cash basis.||Follows accrual basis of accounting.|