In general practices, companies across the world maintain four types of financial statements, namely the balance sheet, income statement, fund flow statement, and cash flow statement. Naturally, each of these statements serves purposes different than the others for both the respective organisation and entities associated with it, either directly or indirectly.
Of these four statements, one that investors and market analysts predominantly use is the fund flow. It is imperative to note here that fund flow is not restricted to a company, but can also cover a narrower or broader scope.
It is easier to understand it by separating the two terms and understanding each individually in the context of financial analysis.
| Fund | Refers to anything that underlines a business’s networking capital like cash or equivalents. |
| Flow | Denotes inflows and outflows or transfer in one word. |
By that understanding, fund flow refers to the difference between cash inflows and outflows in a company for a specific accounting period. This is done by comparing the balance sheets of two accounting periods and contrasting the monetary value against specific working capital items.
For instance, if the accounts receivable item in a company’s balance sheet shows Rs. 10 lakh in FY 2018 – 19 and Rs. 15 lakh in 2019 – 20, it indicates a positive fund flow of Rs. 5 lakh for that period for that specific asset.
However, a parallel understanding of fund flow is also there, which reflects cash movements across variegated financial assets. It allows investors and analysts to determine the cash inflow and outflow to and from a specific asset class like equity or mutual fund. Such flows are prepared on a monthly, quarterly, and annual basis.
In that, fund flow in specific assets or asset classes reflects investments or inflows or divestments or outflows. Theoretically, when there’s a substantial cash inflow within a particular asset class, it indicates more money at the disposal for additional investments. It resultantly improves the demand for such underlying assets.
A primary way in which this flow is used is to determine the health of a specific asset class, sector, or the market as a whole.
For instance, if equities from the financial services sector show a net inflow by a substantial margin, it reflects the healthy condition of that sector. On the other hand, if a specific asset class like bonds shows a net outflow over a significant period of time, then it reflects the poor health of fixed-income instruments.
The fund flow within a company also reflects a similar understanding. For example, if a company is consistently witnessing net outflow of funds, then it is suggestive that such a company is unable to meet working capital requirements efficiently. However, occasional shifts in net inflow and outflow do not suggest anything concrete enough to base a conclusion on the health of a company.
A critical part of fund flow analysis is the determination of investor sentiment by observing the fund flow in asset classes, sectors, or the market.
For instance, if equities across the market witness a waning cash inflow and rising cash outflow, it indicates lessening investments and increasing redemptions. Investors can interpret such a situation as a classic case of broad-base market pessimism regarding market-linked instruments.
Conversely, if let’s say debt-based mutual funds witness augmented net inflow, it shows an inclination towards fixed-income instruments among investors.
In the context of companies, fund flow reflects customer sentiment. Fund flow movements can be brought about by a new product or an innovative venture, shifts in preferences of customers, or any news concerning a company. Naturally, net inflow shows positive sentiment and vice versa.
One can also determine the direction of demand for underlying assets of a specific fund by means of fund flow analysis. When a mutual fund or an exchange-traded fund (ETF) witnesses net inflows, it implies more money at the disposal of such fund managers, which they can invest. It naturally increases the demand for such underlying assets.
On the other hand, if a mutual fund or ETF is witnessing net outflows, then theoretically, such a fund manager has less monetary support to invest, which results in decreased demand for the underlying assets.
Apart from these interpretations, analysts can also identify any out-of-character inflows or outflows by observing the fund flow statement of a company.
For example, a company might have undertaken the purchase of an asset or sold an existing asset to realise such out-of-ordinary fund flow.
Furthermore, such a statement also divulges the sources of funds and uses of funds across a specific accounting period. Analysts can thus understand the competency of a company’s financial management.