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A funds flow statement is a statement that comprises the inflows and outflows of funds. It includes the sources of funds and application of funds for the particular period. Therefore, you can analyse the reasons behind the change in a company’s financial position. This article explains the funds flow statement, its components, importance and limitations.

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What is Fund Flow Statement?

A funds flow statement explains the changes in a company’s working capital. It considers the inflows and outflow of funds (source of funds and application of funds) for a particular period. The statement helps in analysing the changes in a company’s financial position between two balance sheet periods.

The statement helps in determining how the funds are being used. As a result, analysts can assess the company’s fund flow in the future.

Components of a Fund Flow Statement

The statement comprises the following 2 components:

  • Sources of Funds: Includes where the funds have come from and their source.
  • Application of Funds: Denotes the usage of funds for short term and long-term needs.

Fund inflows can be through issues of shares or debentures or from the sale of fixed assets. Or through business operations.

How to Prepare Fund Flow Statement?

The following steps guide you through the preparation of the fund flow statement

Step 1

Prepare a Schedule of Changes in Working Capital. Consider the increase or decrease in the current assets and current liabilities. The difference between the net current assets and net current liabilities gives the net increase or decrease in working capital.

Increase in Working Capital

When the long-term source of funds is more than the application or use of funds, it is referred to as an increase in working capital. Since a company can use these funds for their working capital needs. For instance, payment of short-term loans or dividends can be paid. As a result, an increase in working capital will become part of the ‘Application of Funds’ in the Funds Flow Statement.

Decrease in Working Capital

A company may require more funds but has only a limited long term source of funds. In such scenarios, the company will use the funds available for working capital. As a result, funds available for working capital are reduced. Thus, a decrease in working capital will become part of the ‘Source of Funds’ in the Funds Flow Statement.

Step 2

Prepare the Adjusted P&L Account to find out 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.

Step 3

To create the fund flow statement; you need to identify the Sources of Funds (Inflows) and Application of Funds (Outflows). Identify the source of funds or application of funds (increasing or decreasing) from the balance sheet to create a fund flow statement. And also net increase or decrease in working capital and funds from operations to complete the statement.

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 because the short-term loans are already present 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.

Importance of Funds Flow Statement

The following are the uses and significance of fund flow statement:

  • Financial Position: A profit and loss statement or balance sheet does not explain the reasons for the change in a company’s financial position. The statement will give information about where the funds have come (Source of Funds) and where the funds have been used (Application of Funds).
  • Company Analysis: Often, companies that are making profits end up in cash crunch scenarios. In such scenarios, the funds flow statement offers a clear picture of the source and usage of funds.
  • Management: The funds flow statement assists management in determining its future course of action and also serves as a management control tool.
  • Changes in Assets and Liabilities: The statement shows the reason behind the change in assets and liabilities between two balance sheet dates. As a result, you can conduct an in-depth analysis of the balance sheet.
  • Creditworthiness: Lending institutions use this statement of a company to analyse creditworthiness. They compare the statement over the years before approving a loan. Therefore, the statement depicts a company’s credibility in terms of fund management.

Limitations of Funds Flow Statement

Despite its importance in analyzing the financial position of a firm, the following are the limitations of fund flow statement:

  • The statement focuses only on the movement of funds. It doesn’t consider other parameters that are part of the Balance Sheet and Profit and Loss Account. Therefore, it has to be analyzed alongside the Balance Sheet and Profit and Loss Account.
  • The funds flow statement doesn’t depict the cash position of a company. Hence, a separate cash flow statement has to be made for analyzing the cash position.

How to Interpret a Fund Flow Statement w.r.t Investment in Mutual Funds?

The fund flow analysis helps determine the financial health, investor sentiment, and market demand of the underlying asset.

Determination of Financial Health

The fund flow statement helps determine 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 in managing 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.

On the other hand, if the debt mutual funds see an increase in the net inflows, it may indicate that investors are more inclined to invest in fixed-income instruments.

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

Now that we understood the meaning of a fund flow statement, let’s look at the differences between cash flow statement and fund flow statement:

Point of DifferenceCash Flow StatementFund Flow Statement
Basis of AnalysisThe 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.
SourceShows the opening balance of cash and reaches the closing balance after accounting for inflows and outflows.Determines the various inflows and outflows of funds.
UsageUseful in analysing the short term effects of liquidity of the business.Useful in analysing long term financial health.
Changes in Working CapitalChanges 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.
ComponentsCash flow from operating activities, Cash flow from investing activities and Cash flow from financing activitiesStatement of changes in working capital, and Statement of funds from operations
ResultDetermines the factors that cause changes in cash.Determines the factors that cause changes in net working capital.
Principal of AccountingCFS data obtained on an accrual basis are converted into a cash basis.Follows accrual basis of accounting.

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