The funds flow statement definition is a statement that explains the working capital change in a company. It is an analytical statement of the changes presenting its financial position between two balance sheet statements. It depicts the monetary outflow and inflow of the sources and the applications of funds during a particular period.
Meaning of fund flow statement:
A company prepares a Profit and Loss (P&L) statement and balance sheet, then what is the need for funds flow statement? The P&L Statement and Balance sheet are two statements that portray the financial position for the past and current year. They do not explain why the financial position has changed. That’s where the fund flow statement is required and its need for long and short-term funds. It also explains the following:
- Fund Sources or where the funds came in from with their sources.
- Fund application or where the long or short-term funds have been used.
Example of fund flow statement:
Companies have long-term funds in non-current assets like patents, other investments in various companies, plant and machinery, intellectual property rights, equipment, buildings etc. Thus, non-current assets are created in a financial year whose monetary value is not fully realised in that accounting and financial year. Due to this, two situations arise, such as:
- When the long-term funds finance the non-current assets: The fund flow statement will reflect these assets utilised from the long-term funds. These changes can be understood if the company is using only long-term funds to finance the non-current assets. It is deemed as a healthy organisational behaviour that is growing positively with the proper fund usage.
- When the short term funds finance the non-current assets: The changes in the fund flow statement reflect usage of short-term funds. This is undesirable as it indicates the dangerous use of short-term funds on a long-term investment which is risky. Especially when the company is likely to be cash strapped for its short-term needs and financial obligations since the investments are long-term and cannot be easily liquidated.
Thus, the fund flow analysis can pinpoint the change and application of working capital, be it long or short term funds, through its utilisation and is an index of its financial health. It is widely used to interpret the impact of changes in funds position and its uses in the interim period between two balance sheets through its proper interpretation.
Components of the funds flow statement:
The components of a fund flow statement are its sources of funds which may be from the outside, and capital brought in by the owners, and details on how the funds are utilised namely whether they’ve been used on Fixed Assets or on Current Assets.
Fund flow Statement Benefits:
From the above discussion, one can easily enumerate the benefits of a fund flow statement as:
- An aid to fund managers in explaining the strain on working capital and liquidity of a company, though the P&L Statement may declare it to be profitable.
- It helps the fund managers explain the financial strengths of a company despite its operational losses.
- It helps the fund managers analyse the fund flow and risk level when misusing short-term funds to finance long-term assets. Usually, this is a grey area that is not reflected in either the company's balance sheet or P&L statement.
Who uses the Funds flow Statement?
Of course, the lenders of funds want to know the company's health before investing in it. The funds flow statement would be of a significant area of interest since they assess the utilisation of funds rather than focusing on the operational losses or profits declared in a company's financial statements. An excellent example of this is bankers who utilise the funds flow statement to assess the companies' overdraft and cash credit facilities.
Fund flow statement proforma:
The general format of the fund flow statement would be as below.
Sources of Funds
Application of Funds
Loans and Debts
Operations generated Funds
Sale of assets (if any)
*(Bal fig) Excess of sources minus funds used.
[Working capital Decrease]
Funds utilised in Fixed assets.
Funds utilised in other Non- current assets.
Funds used for repaying loans existing.
Funds used for paying taxes, dividends, etc.
*(Bal fig) Funds minus the application of funds shortage.
[ Working capital increase]
What is working capital?
Working capital is the money used and available for a company’s day to day expenses on business operations. It shows the fluid financial liquidity of the enterprise and is crucial to the continuity and growth of the business. Hence, working capital is required to be used judiciously and managed well. We have just seen how the working capital impacts the funds flow statement and the business's health.
In the definition of fund flow statement, the working capital is shown as the current liabilities and assets and long term or short term capital funds. Let’s explore what these are.
Current assets mean the assets that you can easily convert to cash in the short run. Similarly, current liabilities are those that need to be paid within a year.
Current assets are composed of the following:
- Bank balances
- Cash in hand
- Short-term receivables
- Accounts receivable or to be paid from goods sold.
Current liabilities include the following:
- Accounts to be paid or payable to suppliers
- Short-term owed debts/loans.
Therefore, the working capital formula is the excess or deficit between the Current Assets and the Current Liabilities of a company.
Working Capital = Excess or Deficit between Current Assets and Current Liabilities.
Working capital is positive when the assets are greater and negative when the liabilities are greater.
The working capital ratio is also an essential metric providing insight into the company’s health and is simply expressed as:
Working Capital Ratio = Current Assets divided by the Current Liabilities.
If the ratio of the working capital is more than 1, it is called positive capital, and the company has sufficient cash to pay its short-term debts. If the ratio of working capital is less than 1, it is termed negative capital which means that the company has issues in paying its short-term debts and needs a fresh infusion of working capital.
Reading the funds flow statement:
When there is an increase in working capital:
This situation arises when the networking capital when a business has increased current assets. This can be defined by increased receives or other assets. Or, a decrease in current liabilities may lead to such a situation. This means funds can now be used effectively by the company to meet its working capital requirements, pay its dividends or pay off some of its short term outstanding loans etc., from its long-term sources. Such a company is financially healthy and a good bet for its investors of capital.
When there is a deficit or decrease in working capital:
This situation arises when the company has fewer long-term sources and more fund utilisation points. Such a company has to raise a loan to meet its commitments. Investors would look to invest in the working capital needs of such a profitable company. The company that g ets such working capital facilities can reduce the burden of funds needed for its working capital and use or divert it to create long-term assets.
Due to this, the fund flow statement has various advantages. Apart from highlighting a company's health, it also shows the working capital reductions to generate funds that can be used on long term commitments and how using different assets can effectively change the source of funds by using it appropriately.
Effective understanding of the company’s funds flow statement, and investor input is crucial as it reflects changes in sources of capital and fund utilisation purposes. The excess or deficit in a company’s current liabilities and assets is thus, effectively portrayed only in the funds flow statement and not the P&L Statement or Balance Sheet.
Modern practices to prepare a fund flow statement:
To remain financially sound, every company should frequently analyse its fund flow statement to make adequate business decisions. It also needs its P&L Statement and Balance Sheet to portray the company’s present situation and needs for funds when approaching banks, investors etc., for working capital funds and loans. Today, most businesses use advanced technology for accounting such as Tally or ERP software to draw up these complicated financial statements instantly. Through this, they can use the analytics reports of the software and financial statements. They can use this in strategising and growing the company by making smart business decisions.
Also Read: MIS Report: Definition, Types and Example
In this article, we have discussed the fund flow statement meaning, what a fund flow statement is, and how it impacts the working capital, which is the company's bloodline. We hope we have clearly described how a fund flow statement is vital for explaining the changes during the interim period between two balance sheets because of the change in a company's financial position. For this, you can use Biz Analyst or Cashbook to efficiently handle your accounting.
Biz Analyst is a useful app which helps to stay connected with your business, improve cash flow, and analyse your sales to improve business growth. On the other hand, Cashbook helps in tracking income and expense of business, adding multiple members to cashbook and generating various reports for your company. Therefore, both of these applications can prove to be tremendously beneficial for your company’s safe and secure accounting.