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Unit 09 - Funds Flow Analysis
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Master's in Business Administration (MBA001)
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Unit 9 Funds Flow Analysis
Structure:
9 Introduction
Objectives
9 Definitions
Funds
Flow of funds
Analysis of flow of funds
9 Objectives of Analysing Flow of Funds
9 Steps in Analysing Flow of Funds
Analysing changes in working capital
Computing funds from operations
Identifying sources and applications of funds
9 Preparing the Funds Flow Statement
9 Interpretation of Funds Flow Statement
9 Summary
9 Glossary
9 Terminal Questions
9 Answers
9 Case Study
9 Introduction
In the previous unit we learnt about an important tool of financial analysis –
ratio analysis. The ratio analysis throws light on the profitability and the
soundness of financial position of the company. However, it does not speak
about the soundness of the financial decisions and financial policy of the
company. In order to evaluate the soundness of financing and investment
decisions of the company, we must analyse the changes in the financial
position of the company from one period to another. For this purpose, a
statement of changes in financial position is prepared.
Two important statements of changes in financial position are:
• Fund flow statement
• Cash flow statement
In this unit, we will analyse funds flow statement and in the next unit, the
cash flow statement.
Objectives:
After studying this unit, you should be able to:
- explain the meaning of “funds” and “flow of funds”
- appreciate the need for analysing of flow of funds
- identify sources and applications of funds
- prepare statement of changes in working capital
- prepare adjusted profit and loss account
- prepare fund flow statement
- comment on the financial policy of the company by interpreting the fund
flow statement
9 Definitions
Before we proceed to understand how to make an analysis of flow of funds,
it is important for us to be clear about the exact meaning of the terms used.
These terms are given in the next three sub sections.
9.2 Funds
There are two concepts of working capital.
- Gross working capital – Gross working capital refers to the firm’s
investment in current assets.
- Net working capital – Net working capital means excess of current
assets over current liabilities.
Therefore, the net working capital can be calculated as,
Net working capital = Funds= Current assets - Current liabilities
Current assets – Assets which are held or receivable within a year or within
the operating cycle of the business. They are intended to be converted into
cash within a short period of time.
Current liability – Obligation which has to be discharged within a year.
Table 9 shows the examples of current assets and current liabilities.
Table 9: Examples of Non-Current Assets and Non-Current Liabilities
Non-current liabilities Non-current assets
- Share capital
- Long-term loans
- Debentures
- Share premium a/c
- Forfeited shares a/c
- Profit and loss a/c (credit
balance)
- Appropriation of profits
- Provision for taxation
- Provision for depreciation
- Capital reserve
- Fixed assets
- Fictitious assets like goodwill,
patents, copyrights, and
trademarks
- Long-term investments
- Profit and loss a/c (debit
balance)
- Discount on issue of shares and
debentures
- Deferred expenditures like
preliminary expenses,
advertising expenses
9.2 Flow of funds
The term ‘flow’ refers to change and therefore the term ‘funds flow’ refers to
‘change in funds’ or ‘change in working capital’. In other words, any increase
or decrease in working capital means ‘flow of funds’.
9.2 Analysis of flow of funds
It refers to the process of understanding the reasons that were responsible
for the change in the working capital. It involves identifying the sources and
applications of funds (discussed in section 9.4).
9 Objectives of analysing flow of funds
The analysis of flow of funds is undertaken with the objective of
understanding the following:
- What have been the sources of working capital during the current year?
- What have been the applications of working capital during the current
year?
- Were the long-term investments financed using the long-term sources of
finance?
- How much (what percentage) of working capital has been funded using
the permanent (long-term) sources of finance?
Self Assessment Questions
1. Flow of funds refers to change in funds or ________________.
2. ____ working capital refers to the firm’s investment in current assets.
3. If the firm’s current assets are Rs,000 and its current liabilities are
Rs,000, then its working capital is Rs.________
4. Negative working capital occurs when current assets are ______
current liabilities.
9 Steps in Analysing Flow of Funds
The analysing of flow of funds involves the following steps:
1. Analysing changes in working capital
2. Computing funds from operations
3. Identifying sources and applications of funds
Let us now discuss the steps in detail.
9.4 Analysing changes in working capital
The changes in working capital can be ascertained from the balance sheet,
profit and loss account, and from other information.
There will be a flow of funds if a transaction involves the following:
- Current assets and fixed assets, e., purchase of building for cash
- Current assets and capital, e., issue of shares for cash
- Current assets and fixed liabilities, e., redemption of debentures in
cash
- Current liabilities and fixed liabilities, e., creditors paid off in
debentures
- Current liabilities and capital, e., creditors paid off in shares
- Current liabilities and fixed assets, e., building transferred to creditors
in satisfaction of their claims
There will be no flow of funds if a transaction involves the following:
- Current assets and current liabilities, e., payment made to creditors
through cash
- Fixed assets and fixed liabilities, e., building purchased and payments
made in debentures
- Fixed assets and capital, e., building purchased and payment made in
shares
Total current assets (A)
CURRENT LIABILITIES
Sundry Creditors
Bills Payable
Bank Overdraft
Outstanding expenses
Income received in advance
Provision for Taxation*
Proposed Dividends*
Total current liabilities (B)
NET WORKING CAPITAL
(A)-(B)
Increase/Decrease in Working
Capital (Balancing Figure)
Total
*Provision for Taxation: It can be treated in the following two ways:
1. Treated as current liability – When there is no income tax paid or
additional provision made, it is treated as current liability. It can be taken
to schedule of changes in working capital. No further treatment is
required.
2. Treated as non-current liability – A ledger account (provision for
taxation a/c) is prepared. Sometimes we may have to arrive at income
tax paid during the year from the given information. These are hidden
transactions which are not apparent and are hidden.
*Proposed Dividend: It can be treated in the following two ways:
1. Treated as current liability – Proposed dividend can be taken as
current liability because declaration of dividends by shareholders is
simply a formality. It is taken to schedule of changes in working capital
with no further treatment.
2. Treated as non-current liability – Proposed dividend can be taken as
an appropriation of profit. In such a case, proposed dividend for the
current year will be added back to the current year’s profit. This helps in
finding funds from operations, if such amount of dividend has already
been charged to profit. Payment of dividend will be shown as an
application of fund.
Self Assessment Questions
5. When cash is collected from debtors there is flow of funds. (True/False)
6. When there is sale of fixed assets and cash is obtained, there is flow of
funds because it involves non-current asset and current asset.
(True/False)
7. X Ltd. transfers Rs lakh of its profits to redemption reserve account.
Does it involve flow of funds? (Yes/No)
8. Y Ltd. writes off goodwill during the current accounting period. This
transaction involves flow of funds. (True/False)
9. A firm accepts bills payable drawn by its creditors. Will this transaction
have an effect on the flow of funds? If yes, why?
10. Give one transaction that involves one current liability and one non-
current liability.
11. Give one transaction that involves one current liability and one non-
current asset.
Activity 1:
Give suitable examples (other than the examples given in the SLM)
if there is flow of funds for the following transactions:
1. Current assets and fixed assets, e.,. .......................
2. Current assets and capital, e., ..............................
3. Current assets and fixed liabilities, e., ......................
4. Current liabilities and fixed liabilities, e., ..................
5. Current liabilities and capital, e.,............................
6. Current liabilities and fixed assets, e., ................................
9.4 Computing funds from operations
Revenue transactions such as depreciation, amortisation, profit or loss on
sale of assets, etc. appearing in the profit and loss account does not belong
to either current or non-current category. All such non-operating incomes
and non-operating expenses appear in adjusted profit and loss account to
ascertain the ‘funds from operations’.
Funds from operations – Profit earned by the concern during the current
year is deemed to be the source of funds. It is a very important source of
funds inflow. Net profit is arrived at by deducting cost of goods sold and
other expenses from the total sales revenue. However, the profit calculated
9.4 Identifying sources and applications of funds
The next step is to identify the sources and applications of funds. Following
is the list of transactions that results in a source of fund or application of
funds.
Sources of funds (working capital)
- Funds from operations (i., adjusted net profit as discussed in the
previous section)
- Proceeds of issue of
o Equity shares
o Preference shares
- Proceeds of issue of
o Debentures
o Bonds
- Raising long-term debts from banks and financial institutions
- Raising mortgage loans (long-term)
- Sale of assets
o Tangible assets like land, buildings, equipments, machinery,
vehicles, etc.
o Intangible assets like patent rights, copyrights, brand names,
goodwill, licences, etc.
- Sale of investments like shares, bonds, debentures, etc.
Applications or uses of funds (working capital)
- Funds lost in operations (adjusted net loss)
- Buy back of equity shares
- Redemption of redeemable preference shares
- Redemption of redeemable bonds or debentures
- Repaying of long-term debts from banks and financial institutions
- Repaying of mortgage loans (long-term)
- Purchasing of assets
o Tangible assets like land, buildings, equipments, machinery,
vehicles, etc.
o Intangible assets like patent rights, copyrights, brand names,
goodwill, licences, etc.
- Purchasing of investments like shares, bonds, debentures, etc.
It may be noted that the sources of funds increase the working capital and
applications of funds decrease the working capital.
However, there are certain transactions that do not result in either increase
or decrease of funds. Such transactions are termed as non-fund transaction.
E. if the funds are Rs and a fixed asset of Rs is purchased by
issuing shares of Rs, the funds position will not change and therefore
this transaction will be considered as a non-fund transaction.
9 Preparing the Fund Flow Statement
Having arrived at the change in the working capital, funds from operations
(or funds lost in operations), identified the sources and applications of funds,
the next step is to put them in the form of a summarised statement.
For this purpose, a statement listing the sources of funds and applications of
funds is prepared. This statement is called the statement of sources.
Uses of funds or funds flow statement
It is a statement which depicts the sources from which funds are obtained
and how they have been utilised. When a transaction results in an increase
of funds it is termed as ‘source of fund’ and when it results in a decrease of
funds it is termed as ‘application of fund’.
If during a year, the source of funds was greater than the applications, then
there would be an increase in the working capital and vice versa. This
change (increase or decrease) should be equal to the change (increase or
decrease) as shown by the statement of changes in the working capital.
The format of a funds flow statement is given below.
Funds Flow Statement
For the Year Ending ......
Sources of funds Rs. Applications of funds Rs.
Funds from operations Funds lost in operations
Non-trading incomes Non-operating expenses
Issue of Shares Redemption of Preference
shares
Issue of debentures Redemption of debentures
Borrowing of loans Repayment of loans
Illustration1: XYZ Ltd. provides the following information
January 1 December 31
Sundry Debtors 65,000 1,05,
Cash in hand 13,000 20,
Cash at Bank 15,000 20,
Bills Receivable 16,000 30,
Inventory 90,000 84,
Bills Payables 12,000 8,
Outstanding expenses 6,000 5,
Sundry Creditors 30,000 58,
Bank Overdraft 30,000 42,
Short-term Loans 32,000 36,
Prepare a schedule of changes in working capital
Solution:
Schedule of Changes in Working Capital
Details Balance as on Effect of WC
Jan 1 Dec 31 Increase Decrease
Current Assets
Cash in hand 13,000 20,000 7,
Cash at Bank 15,000 20,000 5,
Sundry Debtors 65,000 1,05,000 40,
Bills Receivable 16,000 30,000 14,
Inventory 90,000 84,000 - 6,
Total Current Assets ( A ) 1,99,000 2,59,
Current Liabilities
Sundry Creditors 30,000 58,000 - 28,
Bills Payables 12,000 8,000 4,000 -
Outstanding expenses 6,000 5,000 1,000 -
Bank Overdraft 30,000 42,000 - 12,
Short-term loans 32,000 36,000 - 4,
Total Current Liabilities ( B ) 1,10,000 1,49,
Working Capital (A) – (B) 89,000 1,10,
Net Increase in working capital
(balancing figure)
21,000 21,
1,10,000 1,10,000 71,000 71,
Illustration 2: The following are the summarised balance Sheet of
Anderson Ltd. Prepare a funds flow statement.
Balance Sheet As On.......
Liabilities 2006 2007 Asset 2006 2007
Sh Capital 5,00,000 6,00,000 F. Assets 10,00,000 11,20,
Reserves 1,50,000 1,80,000 Less: Dep (3,70,000) (4,60,000)
P & L a/c 40,000 65,000 Stock 2,40,000 3,70,
Debentures 3,00,000 2,50,000 Book Debts 2,50,000 2,30,
Creditors 1,70,000 1,60,000 Cash 1,00,000 75,
Prov. for IT 60,000 80,
12,20,000 13,35,000 12,20,000 13,35,
Solution:
Statement of Changes in Working Capital
Particulars 2006 2007 Increase Decrease
Current Asset
Cash 1,00,000 75,
Stock 2,40,000 3,70,000 1,30,000 -
Book Debts 2,50,000 2,30,000 - 20,
Total CA (A) 5,90,000 6,75,
Current Liabilities
Creditors for goods 1,70,000 1,60,000 10,000 -
Provision for income tax 60,000 80,000 - 20,
Total CL (B) 2,30,000 2,40,
Working Capital (A – B) 3,60,000 4,35,
Increase in Working capital 75,000 - - 75,
Total 4,35,000 4,35,000 1,40,000 1,40,
Adjusted Profit and Loss Account
To By
Reserve 30,000 Opening balance 40,
Depreciation 90,000 Funds from Operation 1,
Closing balance 65,
Total 1,85,000 Total 1,85,
Solution:
Schedule of Changes in Working Capital
Balance as on
2006 2007 Increase Decrease
Current Assets
Cash 10,000 13,000 3000
Debtors 25,000 27,000 2000
Stock 37,000 39,000 2000
Total C ( A ) 72,000 79,
Current Liabilities
Trade Creditors 29,000 31,000 2000
Short-term loans 15,000 16,500 1500
Accrued expenses 8,000 7,500 500
Total C ( B ) 52,000 55,
Working capital (A – B) 20,000 24,
Net increase in working
capital
4,000 - 4000
Total 24,000 24,000 7500 7500
Adjusted Profit and Loss Account
To By
Depreciation 1,750 Balance b/d 14,
Goodwill 5,000 Funds generated from
operations ( Balance figure)
12,
Dividend 3,
Balance c/d 17,
TOTAL 27,250 TOTAL 27,
Funds Flow Statement
Issue of fresh equity 15,000 Purchase of fixed assets 30,
Sale of investment 5,000 Payments of dividends 3,
Loan on mortgage 5,000 Increase in working capital 4,
Funds from operations 12,
37,500 37,
Interpretation
- Fixed assets (Rs) have been financed partly out of sale proceeds
of the issue of shares (Rs), partly out of mortgage loan (Rs),
partly out of sale of investment (Rs), and the balance (Rs)
out of funds from operations. It is a good financing policy.
- Dividends have been financed out of funds from operations. It is a good
policy.
Illustration 4: Following is the balance sheet of M/s Mahaveer Enterprise
for the year 1996 and 1997.
Balance Sheet as on 31st March 1997
Liabilities 1997 1998
Share Capital 2,00,000 2,50,
General Reserve 50,000 60,
Profit and Loss 30,500 30,
Bank Loan (long-term) 70,000 -
Sundry Creditors 1,50,000 1,35,
Provision for Taxation 30,000 35,
Total 5,30,500 5,10,
Assets
Land and Building 2,00,000 1,90,
Machinery 1,50,000 1,69,
Stock 1,00,000 74,
Sundry Debtors 80,000 64,
Cash 500 600
Bank - 8,
Goodwill - 5,
Total 5,30,500 5,10,
Additional Information: During the year ended 31st December,
1. Dividend of Rs,000 was paid
2. Assets of another company were purchased for a consideration of
Rs,000 payable in shares. The assets include stock Rs,
machinery Rs,
3. Machinery was further purchased for Rs.
4. Depreciation written off on machinery Rs,
Goodwill A/c
Particulars Rs. Particulars Rs.
To Op. Balance B/d –
To Share Capital A/c
(purchase consideration)
5,000 By Cl. Balance C/d 5,
5,000 5,
Share Capital A/c
Particulars Rs. Particulars Rs.
To Cl. Balance C/d 2,50,000 By Op. Balance B/d 2,00,
By Stock 20,
By Machinery A/c 25,
By Goodwill A/c
(purchase consideration)
5,
2,50,000 2,50,
General Reserve A/c
Particulars Rs. Particulars Rs.
To Machinery A/c 200 By Op. Balance B/d 50,
To Cl. Balance C/d 60,000 By Adjusted P & L A/c 10,
60,200 60,
Bank Loan A/c
Particulars Rs Particulars Rs.
To Cash A/c [Repayment] 70,000 By Op. Bal b/d 70,
To Cl. Balance c/d -
70,000 70,
Provision for Tax A/c
Particulars Rs. Particulars Rs.
To Cash A/c [Tax Paid]
(balancing figure)
28,000 By Op balance B/d 30,
To Cl. Balance C/d 35,000 By Adjusted P & L A/c 33,
63,000 63,
Adjusted Profit and Loss A/c
Particulars Rs. Particulars Rs.
To Dep - Land and Building. 10,000 By Balance C/d 30,
To Depreciation on Machinery 12,000 By Funds from
Operation [Bal Fig.]
88,
To Gen. Reserve A/c 10,
To Provision for Taxation 33,
To Dividend 23,
To Balance C/d 30,
1,18,800 1,18,
Funds Flow Statement
Sources Rs. Applications Rs.
Sale of Machinery 1,800 Purchase of Machinery 8,
Issue of Shares [Purchase of
Stock] *
20,000 Payment of Dividend 23,
Funds from Operation 88,300 Income Tax paid 28,
Decrease in Working Capital
[Balancing Fig.]
18,900 Repayment of Loan 70,
1,29,000 1,29,
* Issue of shares, which involves only current assets, has to be considered
here.
Interpretation:
- Loan has been repaid out of funds from operations.
- Funds from operations have not been sufficient to meet other
commitments like financing the cash purchase of fixed assets and
payment of income tax.
- Despite insufficient funds from operations, the company has paid huge
dividends. It is not an appropriate policy.
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Unit 09 - Funds Flow Analysis
Course: Master's in Business Administration (MBA001)
211 Documents
Students shared 211 documents in this course
University: Manipal University Jaipur
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Financial and Management Accounting Unit 9
Manipal University Jaipur Page No.: 220
Unit 9 Funds Flow Analysis
Structure:
9.1 Introduction
Objectives
9.2 Definitions
Funds
Flow of funds
Analysis of flow of funds
9.3 Objectives of Analysing Flow of Funds
9.4 Steps in Analysing Flow of Funds
Analysing changes in working capital
Computing funds from operations
Identifying sources and applications of funds
9.5 Preparing the Funds Flow Statement
9.6 Interpretation of Funds Flow Statement
9.7 Summary
9.8 Glossary
9.9 Terminal Questions
9.10 Answers
9.11 Case Study
9.1 Introduction
In the previous unit we learnt about an important tool of financial analysis –
ratio analysis. The ratio analysis throws light on the profitability and the
soundness of financial position of the company. However, it does not speak
about the soundness of the financial decisions and financial policy of the
company. In order to evaluate the soundness of financing and investment
decisions of the company, we must analyse the changes in the financial
position of the company from one period to another. For this purpose, a
statement of changes in financial position is prepared.
Two important statements of changes in financial position are:
• Fund flow statement
• Cash flow statement
In this unit, we will analyse funds flow statement and in the next unit, the
cash flow statement.
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