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Distinction Between funds Flow Statement and BalanceSheet

There is also a difference between meaning, purpose andimportance of Funds Flow Statement and Balance Sheetalthough both are prepared with the same accounting data.

A summary of main points of differences between these twois give below:-

(i) Balance sheet is a statement showing the financial

position of the concern on a particular date. The asset sideportrays the development of resources in various type of

properties an liabilities side indicates the manner in whichthese resources are obtained. It shows all assets andliabilities whether current or fixed, tangible or intangible etc.,while Funds Flow Statement shows the changes in currentassets an current liabilities during a particular period of time.

(ii) Balance Sheet shows the total financial position on aparticular date and in this way, it is of a historical nature antherefor, its utility is very limited for the management. Onthe other hand, Funds Flow Statement is a comparativestatement of assets and liabilities and depicts the changes inworking capital during the period of two Balance sheets.

(iii) Funds Flow Statement is an analysis and control devicefor the management. Management can ensure the long terman the short term solvency of the firm by studying theinternal funds flow cycles. It is a modern technique ofknowing the inflows and outflows of funds during a particularperiod. Balance Sheet represents the balance of various

assets an liabilities and does not present analysis of any kind.

(iv) There are two views of h financial position of the firm-

long term an short-term. Short-term financial position meansthe technical solvency of the firm in the near future while on

the other hand, long-term financial position means futurefinancial structure of the firm. Both are inter-relate but thereis a differences in their analysis. The short-term view of the

financial position of the firm ca not be had from the BalanceSheet.

Distinction between funds flow statement and cashflow statement

We have fully explained the meaning and importance of boththe statements-Funds Flow an Cash Flow statements.

A distinction between these two statements may be briefed

as under:-

(i) Funds Flow Statement is concerned with all itemsconstituting funds (Working Capital)for the business whileCash Flow Statement deals only with cash transactions. Inother words, a transaction affecting working capital otherthan cash will affect Funds statement, and not the Cash FlowStatement.

(ii) In Funds Flow Statement, net increase or decrease inworking capital is recorded while in Cash Flow Statement,individual item involving cash is taken into account.

(iii) Funds Flow statement is started with the opening cashbalance and closed with the closing cash balance records only

cash transactions.

(iv) Cash Flow Statement is started with the opening cash

balance and closed with ht closing cash balance while therno opening or closing balances in Funds Flow Statement.

Uses of Cash Flow Statement

Cash Flow statement is an essential tool for short termfinancial analysis an planning.

Its main advantages are as follows:

(i) Planning and Co-ordination of Financial OperationCash Flow Statement is useful is evaluating Financial policand current cash position. Since cash is the basis for carryon operations, the Cash Flow Statement prepared on anestimated basis for the next accounting period will enable

management to plan and co-ordinate the financial operatioprobably. The management comes to know how much casneeded in the future and at what time and how can it bearranged-how much internally and how much from outsideis especially useful in preparing cash budgets.

(ii) A Control Device. Cash Flow statement is also a contdevice for the management. A comparison of cash flowstatement of previous year with the budget for that yearwould indicate to what extent the resources of the enterpr

were raised an applied according to the plan. Thus acomparison of original forecast with actual results mayhighlights trends of movement that might otherwise goundetected.

(iii) Useful to internal Financial Management. Since itgives a clear picture of cash inflow from operations (and nincome flow of operation), it is, therefore, very useful tointernal financial management in considering the possibilitof retiring ling-term debts, in planning replacement of planfacilities or in formulating dividend policies.

(iv) Profit and Cash Positions. It enables the managem

to account for situation when business has earned hugeprofits yet run without money or when it has suffered a losand still has plenty of money at the bank.

(v) Short-term Financial Decisions. Cash Flow Statemehelps the management in taking short-term financialdecisions. Suppose, if firm wants to know its state ofsolvency after one month from to date, it is possible onlyfrom Cash Flow analysis and not from Fund Flow StatemenShorter the period, greater is the importance of Cash FlowStatement.

Cash from Operations

Cash from operations shown in the Cash Flow Statement,

shall be calculated a follows

Cash from operations= Cash sales (Total sales-Credi

sales)- Cash purchases + Cash operating expensesafter adjusting accruals and prepayments).

Cash purchases may be calculated by deducting creditpurchases i.e., increase in accounts payable creditors andB/P from the total purchases.

Cash from operations may also be calculated by makingnecessary adjustments for non-cash transactions in the neprofits as shown by profit and loss account i.e., by addingnon-cash and non-trading payments and losses and by

deducting non-cash an non-trading receipts and profits.

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Preparing a Cash Flow Statement

The statement is prepared annually, half yearly, quarterly ormonthly with the help of two Balance Sheets (one at thebeginning an the other at the end). Income statement andother information available from the receipts anddisbursement account.

Key to preparation of a Cash Flow Statement lies in raising

the fact that all items appearing in income statement are tobe computed on cash basis which so far have been shown anaccusal basis. It is also divided in two parts-(i) Sources ofcash and (ii) Application of cash. All transactions involvinginflow of cash are designated as 'sources of cash' and all

transactions resulting in outflow of cash are summarisedunder the heading 'application of cash'. Cash Flow Statementmay be prepared in two forms:- (i) report form and (ii)Account from as explained below:

Cast-Flow StatementCash Flow Statement is a statement like Funds FlowStatement.

In Cash Flow Statement, the term 'fund' is used to meancash only and does not include even most liquid current assetlike readily realizable accounts receivables while in FundsFlow Statement, 'fund' is used to mean working capital. Itsshows the impart of transactions on cash position of the firmand includes all transactions having a direct impact uponcash. It explains the changes in cash position between thetwo periods.

Form of Funds Flow Statement

Generally, Funds Flow Statement can be prepared in twoformats-in report from or in an account form

1. Cast-Flow Statement2. Cash from Operations

Application of Funds

The following are application of funds

(1) Loss from operations. Loss from operations eitherdecreases the current assets or increases the currentliabilities or in other words reduces the funds. It may eitherbe shown as application of funds in the Funds Statement oras a reduction in sources of funds.

(2) Purchase of Fixed Assets. If any fixed asset likebuilding, machinery, furniture or investments is purchased, itwill reduce the current asset (cash) without anycorresponding decrease in current liability. It is, thus, anapplication of funds. Purchase of asset against issue of sharecapital is not application of funds.

(3) Repayment of loans, Redemption of Debentures orpreference share capital. Any such repayment includingthe payment of premium on redemption of debentures or

preference shares is an application of funds because itreduces the current assets.

(4) Payment of Dividend. Payment of dividend (and notproposed dividend) is an application of fund if paid in cash. Ifbonus shares are issued, it shall not be treated application of

funds.

(5) Other Applications. Any loss such as embezzlement,compensation, donations etc. involving cash, is an applicatof fund.

(6) increase in Working Capital. Increase in workingcapital (as per schedule of changes in working capital)represents investment in current assets hence it is anapplication of funds. In other words, the excess of sourcesover application of funds is increase in working capital.

Sale of Fixed Assets

Set proceeds of any fixed assets such as building, machinefurniture or long-term investments shall generate fundsbecause cash or debtors increase without any correspondiincrease in current liabilities.

But if any fixed asset is exchanged for any other fixed ass

such transaction does not increase current asset or decreacurrent liability hence shall not be taken into account.

Funds from Issue of Debentures, Acceptance of Publ

Deposits and other Long-term Loans

These all sources contribute to funds.

But if debentures like shares, are issued for consideration

other than cash, they do not generate funds.

Funds from issue of Share Capital

Proceeds of fresh issue of share capital (including sharepremium or excluding any discount on issue of shares)increase the current asset (cash or bank) without anycorresponding increase in current liabilities hence is a sourof funds.

But, if shares are issued against the purchase of any fixedasset, it shall not be a source of funds.

Items to be Deducted from Net Profits

In order to find out funds from operations, items of in com(i) which do not affect the current assets or current liabilitand (ii) which are not business income, are to be deducted

from net profit.

Such items are:-

(i) dividend Received or Receivable. Although it increa

current assets (cash or bank or debtors) but it is not abusiness income. Hence, it should be deducted from the nprofit in order to calculate funds from operations and shoube shown in the Funds Flow Statement as a separate itemunder sources of funds.

(ii) Retransfer of Excess Provisions. It simply involvesbook-keeping entry i.e., a transfer of excess provision toprofit and loss account and does not bring any change incurrent assets or current liabilities. Also it does not constit

trading income or profit. Hence it will be deducted from ne

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profit.

(iii) Profits on Sale of Non-Current Assets. Any profitsarising out of sale of fixed assets which have already beencredited to profit and loss account should b deducted fromthe net profit because, it is not a business profit.

(iv) Appreciation of Fixed Assets on Revaluation. If anyfixed asset has been appreciated as a result of revaluationprocess, the amount should be deducted from profits, if it hasalready been credited to profit and loss account.

Calculating Funds From Operations. Funds fromoperations can be calculated by making necessaryadjustments in the profits shown by profit and loss accountas discussed above, in either of the two forms:-

(a) Statement Form. It can be prepared as under:-

Items to be Added of Adjustment of Profit and LossAccount

The following items are added to the net profit as shown bythe profit and loss account

(a) Non-Funds Items. Items which do not increase thecurrent liability or decrease the current asset are non-funditems. These items are as follows:-

(i) Depreciation and Depletion. Depreciation anddepletion do not affect the working capital at all. It is usualpractice in every business to write off depreciation on fixedassets which is debited to profit and loss account and acorresponding credit is made in the respective asset account.In this way, it is only a book-keeping entry, having the effectof reducing the book value of fixed asset as well as the profitby the same amount. Thus it affects only the fixed assets.So, to nullify the effect, the amounts of depreciation and

depletion already debited to P & L Account are added back tothe profits in order to calculate the amount of funds.

(ii) Amortization of Fictitious and Intangible Assets.Amortization of certain fictitious assets in the nature ofDeferred Revenue Expenditure like preliminary expenses,Advertising Suspense Account, discount on issue of Sharesand Debentures, Premium on Redemption of RedeemablePreference Shares or Debentures etc., and writing off ofcertain intangible assets like Goodwill, Trade Marks andPatents are also items which are only bookkeeping enters

and do not affect the current assets or current liabilities atall. They are, therefore, added back to the net profits.

(iii) Provision for Taxation. Provision for taxation madeout of current year's profit also does not affect the flow of

funds. So, it must be added back to the profits.

(b) Non Trading Charges or Losses. Items which are nottrading charges or losses are called non-trading charges orlosses. These are following:-

(i) Appropriation of Retained Earnings. Transfer ofprofits to certain reserves (such as General Reserve,

Dividend equalization fund, Sinking fund, Reserve forcontingencies or any other reserves) does not affect thecurrent assets or current liabilities. Therefore, they will beadded back to the net profits.

(ii) Proposed Dividend on Shares. It is also anappropriation of profits and not a charge and in no way

involves a change in current assets or liabilities. It shall also

be added back to profits.

(iii) Loss on sale of Non Current Assets. Loss on sale ofixed assets such as building, machinery, furniture orinvestment, which has already been debited to P & L Accois not a business loss and does not affect the flow of fundsshould, therefore, be added back to profits.

Adjustment of Profit and Loss Account

The following adjustments are made in the profit and lossaccount to arrive at the figure of profits from operations

(A) Items to be Added(B) Items to be Deducted from Net Profits

Funds from Operations

Sales are the major sources of cash-inflow an at the sametime cost of goods sold and expenses are the main source

cash-outflow.

The difference of these two [i.e., Sales-(cost of goods sold

expenses)] is net profits or net income from operations. Sincome from operation differs from the net profits shown bthe profit and loss account because profit and loss accountincorporates certain items which do not affect the flow (infor outflow) of funds. Profit and loss account is, therefore,adjusted accordingly in order to calculate the profits from

operations.

Sources of Funds

Transactions that increase working capital are sources offunds.

Some of them are:-

(1) Funds from Operations.(2) Funds from issue of Share Capital.(3) Funds from Issue of Debentures, Acceptance ofPublic Deposits and other Long-term Loans.(4) Sale of Fixed Assets.

Procedure of Marketing Funds Flow Statement

Funds Flow Statements is prepared in two parts- The firstone is sources of Funds and the other is Uses of Funds orApplication of funds.

The difference of these two parts, is change in workingcapital. When sources of funds exceed the application offunds, it is increase in working capital and when applicatioof funds exceeds the sources, it is decrease in workingcapital.

Funds Flow Statement presents those items only which affthe working capital. If any transaction does not affect the

working capital at all i.e., if it results in increase or decreain both current assets and current liabilities (such as

payment to creditors) or it affects only fixed assets and fixliabilities (such as conversion of debentures into shares, o

shares into stocks or vice versa, issue of bonus shares,purchase of fixed assets like building or machinery by issu

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of shares or debentures etc.), it is not to be shown in fundsFlow Statement.

Objectives (or Importance) of Funds Flow Statement

Funds Flow Statement is an an analytical tool in the hands offinancial manager. The basic purpose of this statement is toindicate on historical basis the changes in the working capitali.e., where funds came from and were there are used duringa given period.

The utility of this statement can be measured on the basis ofits contributions to the financial management. It generallyserves the following purposes:-

(1) Analysis of Financial Position. The basic purpose ofpreparing the statement is to have a rich into the financialoperations of the concern. It analyses how the funds wereobtained and used in the past. In this sens, it is a valuabletool for the finance manager for analyzing the past andfuture plans of the firm and their impact on the liquidity. Hecan deduce the reasons for the imbalances in uses of funds inthe past an take necessary corrective actions. In analyzingthe financial position of the firm, the Funds Flow Statementanswers to such questions as-

1. Why were the net current assets of the firm down, thoughthe net income was up or vice versa?2. How was it possible to distribute dividends in absence ofor in excess of current income for the period ?3. How was the sale proceeds of plant and machinery used ?4. How was the sale proceeds of plant and machinery used ?5. How were the debts retired ?6. What became to the proceeds of share issue or debentureissue ?7. How was the increase in working capital financed ?8. Where did the profits go?

Though it is not an easy job to find the definite answerers tosuch questions because funds derived from a particularsource re rarely used for a particular purpose. However,certain useful assumptions can often be made and reasonableconclusions are usually not difficult to arrive at.

(2) Evaluation of the Firm's Financing. One importantuse of the statement is that it evaluates the firm' financingcapacity. The analysis of sources of funds reveals how thefirm's financed its development projects in the past i.e., frominternal sources or from external sources. It also reveals the

rate of growth of the firm.

(3) An Instrument for Allocation of Resources. Inmodern large scale business, available funds are always shortfor expansion programmes and there is always a problem of

allocation of resources. It is, therefore, a need of evolving anorder of priorities for putting through their expansionprogrammes which are phased accordingly, and funds haveto be arranged as different phases of programmes get intotheir stride. The amount of funds to be available for theseprojects shall be estimated by the finance with the help ofFunds Flow Statement. This prevents the business frombecoming a helpless victim of unplanned action.

(4) A Tool of Communication to Outside World. FundsFlow Statement helps in gathering the financial states ofBusiness. It gives an insight into the evolution of the presentfinancial position and gives answer to the problem 'wherehave our resources been moving'? In the present world ofcredit financing, it provides a useful information to bankers,

creditors, financial, it provides a useful informations and

government etc. regarding amount of loan required, itsproposes, the terms of repayment an sources for repaymeof loan etc. the financial manager gains a confidence born of a study of Funds Flow Statement. In fact, it carriesinformation regarding firm's financial policies to the outsidworld.

(5) Future Guide. An analysis of Funds Flow Statements several years reveals certain valuable information for thefinancial manager for planning the future financialrequirements of the firm and their nature too i.e. Short terlong-term or mid term. The management can formulate itsfinancial policies based on information gathered from theanalysis of such statements. Financial manager canrearrange the firm's financing more effectively on the basisuch information along with the expected changes in tradepayables and the various accruals. In this way, it guides th

management in arranging its financing more effectively.

Funds Flow Statement

In every concern, the funds flow in form different sources

and similarly funds are invested in various sources ofinvestment.

It is continuous process. The study and control of this fundflow process (i.e., the uses and sources of funds) is the mobjective of financial management to assess the soundnesan the solvency of the enterprise.

The funds-flow-statement is a report on financial operationchanges, flow or movements during the period. It is astatement which shows the sources an application of fundsit shows how the activities of a business is financed in aparticulate period. In other words, such a statement showhow the financial resources have been used during aparticular period of time. It is, thus, a historical statementshowing sources and application of funds between the two

dates designed especially to analyse the changes in thefinancial conditions of an enterprise. In the words of Foulkit is-

A statement of Sources and Application of Funds is technical device designed to analyse the changes inthe financial condition of a business enterprisesbetween two dates.

Funds Flow Statement is not an income statement . Incomstatement shows the items of income and expenditure of a

particular period, but the Funds flow statement is anoperating statement as it summaries the financial activitiefor a period of time. It covers all movements that involve aactual exchange of assets.

Various titles are used for this statement such as 'Statemeof sources and Application of Funds', 'Summary of Financiaoperations,' 'Changes in Financial Position', 'Fund receivedand Disbursed', 'Funds Generated and Expended', ChangeWorking Capital, Statement of Fund' etc. Title of FundsFlow Statement has been modified from time to time. Reait is very difficult to find a short time for such statementwhich carries much to the readers regarding its contents a

functions.

A new interpretation of the term 'funds, has now beenadopted as to include assets or financial resourceful whichnot flow through the working capital accounts. It seems tothe most suitable meaning fort the term 'funds' but the mocommonly used interpretation of the term 'funds' is 'worki

capital'