Understanding the funds flow statement

A company’s cash flow and fund flow statements reflect two different variables during a specific period. The funds flow statement takes both cash and non-cash items for accounting. A funds flow statement is useful to study the funds exactly available for working capital from long-term sources. It also enables the assessment of an entity’s ability to meet long-term obligations. The funds flow takes place only when there is an increase or decrease in working capital owing to movements in long-term sources and uses (application of funds) of funds.

If the long-term source is not increased during the period and term liability is reduced or non-current assets are increased it indicates that the short-term source is utilized for the long-term source. In bankers’ parlance using short-term sources for long-term use is the diversion of funds which has dire consequences for the operation of the entity. The change in working capital is normally assigned to management’s decisions on sources and uses of funds.

Note: Term loan/DPG installments falling due within one year are to be treated as current liabilities.

Advantage of funds flow statement:

The Funds flow statement is useful to analyze the movement of funds in an enterprise and its effect on working capital. For funds flow analyses, the financial analysts use the balance sheet of two consecutive terms to understand the inflow and outflow of funds from the previous financial year to the current year.

The statement provides a detailed account of how funds move through various activities. More importantly, it highlights the sources and applications of capital, including irregularities such as unusual/unexpected outflow. It explains how a company’s net working capital changes over a year by looking at the sources and uses of funds. It can help management align financial strategies with organizational goals. It can help creditors assess creditworthiness and determine a company’s ability to meet its financial obligations. Also, Investors can use the statement to understand a company’s financial stability and growth potential.

Limitations of funds flow statement:

The funds flow statement only focuses on the movement of funds and doesn’t consider other parameters like profitability or loss accounts. It doesn’t show a company’s cash position, so a separate cash flow report is needed for that. To understand the financial status of the company, the statement shall be read along with the balance sheet, profit and loss account, and cash flow statement.

It’s recommended to examine a fund flow statement alongside the balance sheet and profit and loss account to better understand a company’s financial status.

The formula used to analyse the funds’ flow involves subtracting the total uses of funds from the complete sources of funds, providing the net change in the organization’s financial position. In other words, Fund Flow = Total Sources of Funds—total Uses of Funds.

Fund flow statements explain how a company’s net working capital changes over a year by looking at the sources and uses of funds. They include depreciation as an expense but can provide an incomplete picture of a company’s financial health because they don’t account for other non-cash transactions. Overlook significant non-cash transactions and adjustments. Non-cash items such as depreciation, amortization, changes in working capital, and accrual-based accounting adjustments are critical for assessing profitability and financial performance.

Fund flow analysis focuses primarily on cash flows and may overlook significant non-cash transactions and adjustments. Non-cash items such as depreciation, amortization, changes in working capital, and accrual-based accounting adjustments are critical for assessing profitability and financial performance. A funds flow statement helps explain the source of funds and its utilization or application, allowing the users of financial information to interpret and know the impact on the business.

Related Posts: