Funds Flow Statement

A Funds Flow Statement is a financial document that analyses a company’s Balance Sheet of two years to validate the movement of funds from the previous financial year to the current year. In other words, it compares the source of inflow and outflow of funds during the concerned accounting period and analyses how it affects the working capital of an organization.

It is an essential determiner that shows how funds are used. With the help of this statement, financial analysts can assess the fund flow of an organization in the near future.

As this statement portrays the movement of funds among several sources and their applications, it is also known as the Application of the Funds and Statement of Sources.

Usually, the preparation of these statements is followed by a funds flow analysis. It serves as a financial parameter that helps a company to control its finance and develop a better strategy to utilize funds.

What is a Funds Flow Statement Analysis?

Funds Flow Statement analysis is a comparison between various aspects of a Balance Sheet. While evaluating this statement, it is also vital to understand all the aspects.

• Assets

If the asset section of a Balance Sheet experiences increment, it implies that the concerned institution has purchased assets by spending funds. These assets might thus result in the inflow of funds in the future. Here are some examples –

• Fixed assets
• Short-term loans
• Long-term loans
• Inventory
• Cash and cash equivalents
• Receivables
• Present investments

Contrarily, if the assets section shows a decline, it means that the company has sold some of its assets to maintain fund inflow.

• Liabilities

In a Funds Flow Statement, any increase in liabilities means the organization has funds inflow which needs to be paid. Some of the examples are-

• Lenders
• Customers
• Vendors
• Employees
• Shareholders

And, a decline in liabilities implies that the current obligations have been satisfied.

How is a Funds Flow Statement Prepared?

Preparation of Funds Flow Statement is done in the following three steps –

• Statement depicting differences in working capital

According to the formula for working capital calculation,

Working capital = Current assets – Current liabilities

This particular statement focuses on the effects that modify working capital. Here are some reasons that are responsible for a change in the company’s working capital.

• If the company keeps investing in fixed assets or long term business avenues without accumulating any long term funds, the working capital can reduce significantly.

• If the company is spending most of its profit in paying dividends and not accumulating any assets.

• Working capital can also change with an over-extension in lending.

• Again, without any advancement of long term funds, if the firm needs to repay a long-term obligation or preferred stockholders, the concerned firm can come across working capital deficiency.

• Example

Following is an example of changes in working capital in the statement –

• Statement depicting funds from various operations

In the next step, the report carries only the funds flow from operational activities. In this statement, the current year’s profit and loss are calculated along with an adjustment in depreciation or accounting of the loss on fixed asset sales. Now, the previous year’s profit or loss is to be deducted from the previous calculation to arrive at the value of funds from operations.

Note that no financing or investing activities will be accounted for in this statement.

• Statement depicting the flow of funds

This is the final step to calculate the flow of funds. Thus, the effect of previous calculations will be taken into account to understand the accurate use of funds. The adjustments are elaborated below.

Uses of Funds Flow Statement

A statement of the business’s funds flow is an essential financial tool to monitor and regulate working capital. Below are some uses of Funds Flow Statement that financial analysts and managers opt for.

• Analytical importance in financial operations

Even though financial statements show the resources and their utilisations, it doesn’t reveal the reasons for such changes in the Balance Sheet. The statement thus provides an analytical view of the differences between current assets and current liabilities. Hence, it also explains how these changes take place in the context of the funds of a concerned company. In some cases, even if the company runs on profit, scenarios of cash shortage may arise. In such circumstances, this statement provides a clear picture of the profit earned by an organization.

• Helps to form effective dividend policy

Sometimes a firm possesses substantial available profit to be distributed as a dividend but finds it difficult to do so due to a lack of sufficient liquidity. A Funds Flow Statement thus helps identify liquidity blockage and assists in planning an effective dividend policy.

• Works as a financial guide

This statement also serves as a financial guide for a company. It brings out the financial issues that a concerned company could face in the near future. The management can thus chalk out an appropriate strategy to protect the company from any significant future financial loss.

• Helps to determine the creditworthiness of an organization

Institutions lending finances often opt to evaluate this statement for a series of years to assess the creditworthiness of an applicant company before approving a loan. Hence, it also portrays the credibility of a firm in terms of fund management.

Limitations of Funds Flow Statement

In spite of several essential utilities, financial analysts encounter some Funds Flow Statement problems indicating at the limitations to its use.

• This statement cannot portray financial parameters represented in a Balance Sheet or Income Statement. It only focuses on the movement of funds during a specific timeline and does not quantify other essential items.

• The statement doesn’t add any new numerical value to a company’s financial standing. It only re-arranges the available information to identify issues with fund management.

• Due to its historical nature, this statement can’t conclude with accuracy the present-day financial standing of a business.

• Working capital plays an essential role in business finance. However, the movement of cash is more important for a promising financial future of a business. Thus, the flow of funds does not serve as an effective barometer for the purpose.

However, even with the limitations of this statement, it helps financial analysts to evaluate the balance sheet and come up with suggestions to operate funds effectively. Hence, every small and big organization must know about their fund movement to make improved financial decisions.