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.
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.
The statement comprises of 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?
To prepare a funds flow statement, you have to follow the below steps:
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.
Prepare the Adjusted P&L Account to find out Funds from Operations.
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.
Importance of a Funds 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 the this statement of a company to analyse the 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 statement has the following limitations:
- 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.