Every business concern, at the end of its financial period, prepares Income Statements and Balance Sheet. Income Statements show the net result, Net Profit, of the business operations and contains various expenses incurred and losses and revenue earned during that period. Balance Sheet gives a summary of assets and liabilities as on a particular date and shows the financial position of the business. The liabilities side of a balance sheet shows the sources from where funds are raised and the assets side shows how the funds raised are utilized.
But it does not show the causes or reasons for changes in assets and liabilities, flow of funds, between two balance sheet dates. Therefore, a statement is prepared in addition to the Income Statements and Balance Sheet, to show changes in assets and liabilities between two balance sheet dates, which is known as Fund Flow Statement. It is a statement, also known as Statement of Changes in Financial Position, designed to analyse the changes in financial condition of a concern between to specified dates. The Term “Fund”
The term “Fund” can be explained in many ways. In the narrow sense, it means cash only. Transactions involving cash receipts and payments are considered in this approach. In the broader sense, fund means working capital, which is the excess of current assets over current liabilities. For fund flow analysis, the broader approach, working capital approach, is considered. The word “Flow” means change and “fund flow” means change in funds or change in working capital. Any increase or decrease in working capital is flow of funds.
Flow of funds may be either inflow of funds or outflow of funds. Inflow refers to sources of funds and outflow refers to applications of funds. If a transaction brings any change in working capital, flow of funds takes place. This will happen when changes occurs in the values of fixed assets, share capital, long term debts etc. with the corresponding changes in the values of current assets or current liabilities. Many transactions which take place in a business enterprise may increase or decrease its working capital or even may not affect any change in it.
Following are some examples: Purchase of fixed assets: When an asset is purchased, cash is going out there by reducing the cash balance. The effect of this transaction is that working capital decreases and this change (decrease) in working capital is called as application of funds. Here the accounts involved are Current Assets (Cash) and Fixed Assets. Issue of share capital: This transaction will increase the working capital as cash balance increases. This change (increase) in working capital is called as source of funds. Here the two accounts involved are current assets (Cash) and Shareholders’ Funds (Share Capital).
Sale of Fixed Assets: The transaction will have the effect of increasing the working capital as the cash balance increases thereby increasing working capital. It is a source of funds. Here the accounts involved are current assets (Cash) and Fixed Assets. Redemption of debentures: This transaction has the effect of reducing the working capital, as it results in reduction in cash balance. It is an application of funds. The two accounts affected by this transaction are Current Assets (Cash) and Long-Term Liability (Debenture).
Purchase of inventory: This transaction results in decrease in cash and increase in stock thereby keeping the total current assets at the same figure. Hence there will be no change in the Working Capital. In this case both the accounts involved are Current Assets (Cash and Stock). Accepting Bills Payable issued by creditors: The effect of this transaction on Working Capital is Nil as it results in increase in bills payable (a current liability) and decreases the creditors (another current liability). Since there is no change in total current liabilities there is no flow of funds. The accounts involved as current liabilities.
Fixed Assets purchased and payment is made by issuing shares: This transaction will not have any impact on working capital as it does not result in any change either in the current asset or in the current liability. Hence there is no flow of funds. The two accounts affected are Fixed Assets and Shareholders’ Funds (Capital a/c). From the above examples, it is clear that there will be flow of funds when the transaction involves: a) Current assets and fixed assets b) Current assets and capital c) Current assets and long term liabilities d) Current liabilities and long term liabilities e) Current liabilities and fixed assets.