Fund Flow Statement Overview

Introduction to Fund Statements

Traditionally, companies publish two primary financial statements in their annual reports: the Income Statement (Profit and Loss Account), which reflects trading results over the fiscal year, and the Balance Sheet (Position Statement), which outlines the enterprise’s financial standing at a specific point in time. However, modern accounting practices have evolved to prioritize maximum transparency for stakeholders. Beyond tracking assets, liabilities, profits, and losses, understanding where a company’s funds originated and how they were spent during the accounting period is essential.

This dynamic financial movement is captured through a Statement of Source and Application of Funds (Fund Flow Statement). While standard income statements and balance sheets offer static snapshots, they fail to track active fund variations over time. For instance, if a company’s current balance sheet lists a Debentures Account of Rs. 1,00,000 that was absent the previous year, a fund statement explicitly reveals that these fresh funds entered the business through a new debenture issuance. Consequently, the fund statement illustrates structural financial shifts far more dynamically and clearly than a simple comparative analysis of opening and closing balance sheets.

What Does “Fund” Mean?

In business and accounting, people often think “fund” means only cash. However, in a Fund Flow Statement, funds actually refer to Net Working Capital (the difference between current assets and current liabilities).

This means funds can change even when no cash is immediately exchanged. For example, if a company buys machinery on credit, its liabilities (what it owes to suppliers) increase. This changes the working capital, meaning the funds have been affected. Therefore, a Fund Flow Analysis tracks every financial activity that impacts a company’s working capital.

Sources and Application of Funds

The flow of funds can be summarized by two main rules:

• When liabilities increase or assets decrease, it brings funds into the business. This is a Source of Funds.
• When assets increase or liabilities decrease, it uses up the company’s funds. This is an Application of Funds.

1. Sources of Funds (Where funds come from)

• Increase in Capital: Owners or investors putting more money into the business.
• Borrowing: Taking out loans or issuing debentures.
• Business Profits: Making money from regular business operations.
• Selling Assets: Selling fixed assets or investments.

2. Application of Funds (How funds are used)

• Buying Assets: Purchasing fixed assets like machinery or making new investments.
• Paying off Debts: Repaying loans or debentures.
• Paying Dividends: Distributing cash profits to shareholders.
• Operating Losses: Losing money from regular business operations.

Preparation of a Fund Flow Statement

A fund flow statement shows how money moves into and out of a business. You can format it as a T-shape, listing sources of funds on the left and their applications on the right. However, most people prefer the vertical format. In this format, you list sources first and applications second.

To build this statement, you need balance sheets from at least two consecutive years. These comparative balance sheets show the financial status at the start and end of the period. By comparing them, you can find how changes in assets and liabilities affect your funds. You also need details from the Profit and Loss Account to see how daily business operations impact your funds. For example, operating profit acts as a source of funds.

Comparing the opening and closing balances of assets and liabilities reveals the net financial effect. For instance, to prepare a 2003 statement, you compare the 2002 and 2003 balance sheets. If your machinery account grows from Rs. 1,00,000 in 2002 to Rs. 1,80,000 in 2003, it means you spent Rs. 80,000 to buy new machinery.

People also call the Fund-Flow Statement by other names, such as “The Statement of Sources and Application of Funds”, “Where got-Where gone Statement”, or “Statement of Funds Supplied and Applied”.

Utility of Funds-Flow Statements

A funds-flow statement shows how money moves between the dates of two balance sheets. While a balance sheet shows assets and liabilities on a specific date, and a profit and loss account shows yearly trading results, neither reveals where money came from or where it went. External users mainly look at these two traditional statements. In contrast, managers use funds-flow statements for practical guidance and decision-making.

Here is how the statement helps management:

1. Explains financial contradictions: It clarifies complex situations for managers who lack a background in accounting. For instance, a company might show high profits every year while running out of cash. The funds-flow statement explains this contradiction by showing exactly where the net profits went, such as buying fixed assets for business expansion.
2. Allocates scarce resources: It helps managers allocate limited money to the most profitable projects. By preparing a projected funds-flow statement, managers can plan which projects to fund as money becomes available.
3. Helps secure loans: When a company applies for loans from banks or lenders, the financial manager uses projected funds-flow statements to prove creditworthiness. The statement answers key questions about how much money the business needs, when it needs it, when it will repay the loan, and how it will generate the cash for repayment.
4. Warns of cash shortages: A projected statement alerts managers about future cash shortages, helping them avoid financial trouble and embarrassment.

Limitations

While the funds-flow statement provides valuable insights, managers must use it cautiously. It relies on secondary data from traditional financial statements rather than primary information. Additionally, because it uses historical data, it offers limited help for future planning.

FUND-FLOW STATEMENT (Vertical Format)

A fund flow statement is typically created to analyze a single year, though it can span multiple years if needed. The primary data required for this statement comes directly from the opening and closing balance sheets. Additional details, such as dividends paid, are sourced from external records like the Profit and Loss Appropriation Account. Once gathered, this financial information can be structured into either a horizontal or a vertical layout.

Based on the image provided, here is a transcription of the Statement of Sources and Application of Funds format:

Statement of Sources and Application of Funds

STATEMENT OF CHANGES IN WORKING CAPITAL

It is the usual practice to show the changes in the working capital in a separate statement. The working capital is the excess of current assets over current liabilities. Hence only current assets and current liabilities are shown in the statement showing changes in working capital.

While preparing this separate statement, the following points should be noted :

Working Capital=Current Assets-Current Liabilities

This suggests that :

(1) Working Capital increases if there is any increase in the current assets,
e.g. if the current assets are worth Rs. 1,00,000 and current liabilities are Rs. 40,000 then working capital = 1,00,000 – 40,000 = 60,000.

If the current assets increase to Rs. 1,20,000 then the working capital will also increase to Rs. 80,000.

Working Capital=1,20,000-40,000=80,000

(2) Working capital decreases if there is any decrease in current assets.

Conversely, working capital decreases if there is any increase in current liabilities and increase if there is any decrease in current liabilities.

Here is the structured table based on the format provided in the image:

Schedule of Changes in Working Capital

For the year ending…

Note: The last two columns show changes in working capital and not the changes in individual current assets or liabilities.