Management Accounting

Chapter 4 : Fund Flow Statement (FFS)

 Meaning of Funds
The term ‘funds’ has several meanings. In a narrow sense, ‘funds’ means cash and a funds flow statement is
prepared based upon this premise only. In a broader sense, ‘funds’ is considered to be equivalent to money. In a
popular sense, a fund means working capital. The term working capital is defined as the excess of current assets
over current liabilities.

Funds can be:

o Cash or cash equivalents
o Current Assets less Current Liabilities i.e, Net Working Capital
o Total funds
o Equity Capital
o Reserves

 Concepts of Working Capital

There are also two concepts of working capital - gross working capital and net working capital.

Gross working capital refers to the total amount a firm invested in current assets,

Net working capital means excess of current assets over current liabilities (Current Assets – Current Liabilities)

Working Capital

Gross Working Capital Net Working Capital

Current Assets Current Assets – Current Liabilities

 Meaning of Current Assets and Current Liabilities

Current assets refer to those assets which can be easily converted in to cash normally within a period of one year.
While current liabilities are those liabilities which have to be paid in the ordinary course of time i.e. normally
liabilities have to be settled within a period of one accounting year.

List of Current Assets and Current Liabilities

Current assets Current liabilities

Cash in hand Sundry creditors
Cash at bank Bills payable/Accounts payable
Bills receivables Bank overdraft
Sundry debtors/Accounts Short term loan
receivables Outstanding expenses
Short term advances
Short term investments Provision for doubtful debts
Stocks (raw materials, work-in- Income received in advance
progress, stores and spares, and
finished goods)
Prepaid expenses
Accrued income

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 Introduction :

We all know that the objects of preparing financial statement with the help of Income statement or, Profit and Loss
Account and Balance Sheet is to supply the financial information to the users of financial statements as far as
possible No doubt, in order to serve such basic objectives, the Income Statement and the Balance Sheet serve very
well.

The Balance Sheet exhibits the financial position at the end of the period through the assets (which show the
development of resources in various types of properties) and liabilities (which present how these resources were
taken).

The Income Statement, on the other hand, measures the results of the operation at the end of the period, i.e., the
change in the owner’s equity as a result of the productive and commercial activities for the period.

Thus, the above two statements are very useful although there are other significant relationship between the two
Balance Sheets (opening and closing accounting periods) on which the conventional above two statements cannot
throw any light further.

For this purpose, it becomes necessary to know what funds are available during the period and application of such
funds along with the profit that has been earned as a result of the business activities. So, in order to know such
changes in the financial position, it is necessary to prepare a statement known as Funds Flow Statement which will
exhibit such financial information to the users of financial statement.

 Meaning and Definitions of Funds Flow Statement

The term funds flow statement is concerned with the changes occurring in financial position of a business
enterprise between beginning and ending financial statements dates. It also reveals the sources and uses of funds
for a period of time.

I.C.W.A in Glossary of Management Accounting terms defines funds flow statement as “a statement prospective or
retrospective, setting out the sources and applications of the funds of an enterprise. The purpose of the statement
is to indicate clearly the requirement of funds and how they are proposed to be raised and the efficient utilization
and application of the same.”

Non-current assets. All assets other than current assets come within the category of non-current assets. Such
assets include goodwill, land, building, machinery, furniture, long-term investments, patent rights, trade marks,
debit balance of the profit and Loss Account, discount on issue of shares and debentures, preliminary expenses, etc

Non-current liabilities. All liabilities other than current liabilities come within the category of non-current
liabilities. Such liabilities include Equity share capital Preference share capital, Debentures, Long-term loans, Share
forfeited, Profit and Loss Account (profit), Capital reserve, and Capital redemption reserve

List of Non-Current Assets and Non-Current Liabilities

Non-current assets or fixed assets Non-current liabilities or long-term liabilities
Goodwill Equity share capital
Land Preference share capital
Building Debentures
Plant and Machinery Long-term loans
Furniture and Fittings Share forfeited
Trademark Profit and Loss Account (profit)
Patent Capital reserve
Long-term investments Capital redemption reserve
Discount on issue of shares and
debentures
Other deferred expenses

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 Difference Between Funds Flow Statement and Income Statement
Funds flow statement is not a substitute of income statement (Profit and Loss Account). Income statement is a
document which indicates the operational results by showing profits earned on loss incurred by a business
undertaking. It reports the results of business activities and indicates the reasons for the profitability or otherwise.
It does not either highlight the changes in the financial position of a business or reveal the inflows and outflows of
funds in business during a particular period. It is a shortcoming of an income statement compared to a funds flow
statement.

Funds flow statement is not competitive but complementary to financial statements. It provides additional
information regarding changes in working capital, derived from financial statements at two points of time. It is a
tool for management to do financial analysis which is important for decision making.

Difference between Funds Flow Statement and Income Statement are as follows:
1. Funds flow statement highlights the changes in the financial position of a business and indicates the
various means by which funds were obtained during particular period and the ways by which these funds
were employed whereas income statement does not reveal the inflows and outflows of funds but depicts
the items of expenses and income arrived at the figure of profit or loss.
2. Funds flow statement is complementary to income statement. It helps preparation of funds flow statement.
Income statement is not prepared from funds flow statement.
3. While preparing funds flow statement, both capital and revenue items are considered, but for the
preparation of income statement, only revenue items are taken into account.
4. There is no prescribed format for preparing a funds flow statement. But income statement is prepared in a
prescribed format.

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 Difference Between Funds Flow Statement and Balance Sheet
A Balance sheet is a statement which reveals the financial position or status of a business on a given date. It is
prepared at the end of the accounting period. Balance sheet contains various assets and liabilities of an
undertaking. Funds flow statement tells us many financial facts which a Balance sheet fails to do so. Balance Sheet
fails to disclose the causes for changes in the assets and liabilities between two different points of time. Again,
while Balance Sheet is the end result of all the accounting operations for a period of time, funds flow statement is
essentially a post Balance Sheet exercise. Funds statements are prepared to show the various sources from which
the funds came into business and the various applications where they have been used.

The main difference between funds flow statement and balance Sheet are as follows:

1. Funds flow statement is a statement of changes in financial position and, hence, is dynamic in nature. But
Balance Sheet is a statement of financial position on a particular date hence is static in nature.
2. Funds flow statement shows the sources and the uses of funds in a particular period of time, whereas
Balance Sheet depicts the assets and liabilities at a particular point of time.
3. Funds flow statement is a tool of management for financial analysis, which helps making decisions, but
income statement is not of much help to management in decision-making.
4. Usually, a schedule of changes in working capital has to be prepared before preparing funds flow
statement. But no such schedule of changes is required for the preparation of Balance Sheet. Preparation of
balance sheet is preceded by preparation; Profit and Loss Account.

 What is Flow of Funds?

The Term ‘Flow’ means ‘Movement of Funds’ (inflow of Fund and Outflow of Fund). It implies this statement tells
about the inflow and outflow of the funds during a financial year.

In other words, Fund Flow Statement is an analytical statement prepared for comparative purposes
between two consecutive years.
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 Meaning of Funds Flow Statement :

Funds flow statement is a statement which discloses the analytical information about the different sources of a
fund and the application of the same in an accounting cycle. It deals with the transactions which change either the
amount of current assets and current liabilities (in the form of decrease or increase in working capital) or fixed
assets, long-term loans including ownership fund.

It gives a clear picture about the movement of funds between the opening and closing dates of the Balance Sheet.

It is also called the Statement of Sources and Applications of Funds, Movement of Funds Statement; Where Got-
Where Gone Statement; Inflow and Outflow of Fund Statement, etc. No doubt, Funds Flow Statement is an
important indicator of financial analysis and control. It is valuable and also helps to determine how the funds are
financed. The financial analyst can evaluate the future flows of a firm on the basis of past data.

This statement supplies an efficient method for the financial manager in order to assess the:
(a) Growth of the firm,
(b) Its resulting financial needs, and
(c) To determine the best way to finance those needs.
In particular, funds flow statements are very useful in planning intermediate and long-term financing.

 Objective of Preparing a Fund Flow Statement:

1. The main purpose of preparing a Funds Flow Statement is that it reveals clearly the important items
relating to sources and applications of funds of fixed assets, long-term loans including capital. It also
informs how far the assets derived from normal activities of business are being utilized properly with
adequate consideration.
2. Secondly, it also reveals how much out of the total funds is being collected by disposing of fixed assets, how
much from issuing shares or debentures, how much from long-term or short-term loans, and how much
from normal operational activities of the business.
3. Thirdly, it also provides the information about the specific utilization of such funds, i.e. how much has been
applied for acquiring fixed assets, how much for repayment of long-term or short-term loans as well as for
payment of tax and dividend etc.
4. Lastly, it helps the management to prepare budgets and formulate the policies that will be adopted for
future operational activities

 Significance and Importance of Funds Flow Statement:

Since traditional reports (i.e. Income Statement/Profit and Loss Account, and Balance Sheet) are not very
informative, a financial analyst has to depend on some other report - Funds Flow Statement.

In other words, along with the traditional sources of information, some other sources of information are absolutely
required in order to take the challenge offered by modern business.

Funds Flow Statement, caters to the needs of management. This is because a Funds Flow Statement not only
presents the Balance Sheet values for consecutive two years, it also ascertains the changes of working capital -
which is a very important indicator.

It not only reveals the source from which additional working capital has been financed but also, at the same time,
the use of such funds. Moreover, from a projected funds flow statement the management can easily ascertain the
adequacy or inadequacy of working capital, i.e., it helps in decision-making in a number of ways.

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The significance and importance of Funds Flow Statements may be summarized as:

1. In the Analysis of Financial Operations : The funds flow statement explains causes for changes and also
the effect of such changes on the liquidity position of the company. Suppose a company may be having
operating profit but still its cash position may be bad. The funds flow statement gives clear answers to this
situation.

2. It Helps to the Formation of a Good Dividend Policy : Sometimes a firm may not be able to distribute the
dividends to its equity shareholders for wanting of liquid cash despite the fact that the firm has made
sufficient profits. The funds flow statement helps the firm in such a circumstance.

3. It Helps in the Proper Allocation of Resources : A projected funds flow statement helps the firm for the
best deployment of the resources available with the firm.

4. It Acts as a Future Guide : A projected funds flow statement helps the company to identify the future
needs of the funds and thereby the company can take necessary initiatives to arrange the funds.

5. It Helps in Determining Working Capital : A funds flow statement helps in explaining how efficiently the
management has used its working capital and also suggests ways to improve the working capital position
of the firm.

6. Highlighting Answers to Various Perplexing Questions : Funds Flow Statement highlights answers of
the following questions:
(i) Causes of changes in Working Capital;
(ii) Whether the firm sells any Non-Current Asset; if sold, how were the proceeds utilized?
(iii) Why smaller amount of dividend is paid in spite of sufficient profit?
(iv) Where did the net profit go?
(v) Was it possible to pay more dividend than the present one?
(vi) Did the firm pay-off its scheduled debts? If so, how, and from what sources?
(vii) Sources of increased Working Capital, etc.

 Parties Interested in Funds Flow Statement :

(a) Share-Holders :They are interested in knowing how much is available for the payment of dividend and the
position of their investment in the company.

(b) Short-Term Creditors (including bankers) :They are interested in having an idea of the risk which may be
involved in granting credit to the company.

(c) Management : Management is interested in knowing the trend of different forms of financing and their
utilization so that they can prepare budgets and estimates. They are also interested in knowing whether the
working capital has been properly utilized.

(d) Investors : They are interested in knowing whether any investment can be made in the company and if so,
what should be the expected rate of return.

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Importance of Fund Flow statement

1. Fund Flow Statement determines the financial consequences of business operations. It shows how the funds
were obtained and used in the past. Financial manager can take corrective actions.

2. The management can formulate its financial policies - dividend, reserve etc. on the basis of the statement.

3. It serves as a control device, when comparing with budgeted figures. The financial manager can take remedial
steps, if there is any deviation.

4. It points out the sound and weak financial position of the enterprise.

5. It points out the causes for changes in working capital.

6. It enables the Bankers, Creditors or financial institutions in assessing the degree of risk involved in granting
credit to the business.

7. The management can rearrange the firm’s financing more effectively on the basis of the Statement.

8. Various uses of funds can be known and after comparing them with the uses of previous years, improvement or
downfall in the firm can be assessed.

9. The statement compared with the budget concerned will show to what extent the resources of the firm were
used according to plan and what extent the utilization was unplanned.

10. It tells whether sources of funds are increasing or decreasing or constant.

Limitations of Fund Flow Statement:

1. The Statement lacks originality because it is only rearrangement of data appearing in accounts books.

2. It indicates only the past position and not future.

3. It indicates Fund Flow in a summary form and it does not show various changes which take place continuously.

4. When both the aspects of a transaction are current, they are not considered.

5. When both the aspects of a transaction are non-current, even then they are not included in this statement.

6. It is not an ideal tool for financial analysis.

7. It is not an original statement but simply a rearrangement of data in the financial statements.

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 Management of Working Capital

The statement tells about the working capital changes as well. This ensures the availability of working capital for
day-to-day operations of the business.

Helps in generating long-term financing for business : The Fund Flow Statement reveals the actual long-term
financing the business has already pursued. This gives the business an idea of the next long-term financing
prospects to be undertaken.

Easy identification of threat factor in business : The statement reveals all the major categories of funds sources
and application. This helps in easy identification of threats in business funding wherein taking corrective measures
becomes easy.

Helps in future forecasting : The Fund Flow Statement acts as a future guide for business as it depicts the fund
statement for the two consecutive years. Hence, it helps in making future forecasts about funds requirement and
gives an idea of the fund allocation.

Reveals about the exact creditworthiness of the business : This statement reveals the fund utilization of the
business and the availability of funds for paying off the obligations. This showcases the exact creditworthiness of
the business.

The following items that will cause a change in Working Capital:

A. Increase in Working Capital:

i. Issue of Shares and Debentures;
ii. Sale of Fixed Assets or Non-Current Assets;
iii. Income from different sources.

B. Decrease in Working Capital:

(i) Redemption of Preference Shares or Debentures;
(ii) Purchase of Fixed Assets or Non-Current Assets;
(iii) Payment of Miscellaneous Expenses;
(iv) Payment of Dividend etc.

The following items do not bring about any change in Working Capital:
i. A shift from one current asset to another current asset by an equal amount or from one current liability
to another current liability by an equal amount
ii. An increase in current assets by a corresponding equal increase in current liabilities;
iii. A decrease in current assets by a corresponding equal decrease in current liabilities;
iv. An increase in non-current assets by a corresponding equal increase in non-current liability
v. A decrease in non-current liability by a corresponding equal increase in non- current liability.

In Simple :

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Movement of Funds : Inflow of Funds and Out flow of Funds

Procedures for Preparing Funds Flow Statement

Funds flow statement is a method by which we study changes in the financial position of a business enterprise
between beginning and ending financial statement dates.
Hence, the funds flow statement is prepared by comparing two Balance sheets and, with the help of such, other
information derived from the accounts, as may be needed. The preparation of a funds flow statement consists of
three steps :

1. Schedule of changes in working capital which shows whether there is increase in working capital or
decrease in working capital.
2. Funds from Business Operation or adjusted profit and loss account which exhibits funds from operation
3. Funds flow statement reveals the sources and uses of funds

Step 1 : Statement of Schedule of Changes in Working Capital

The statement of schedule of changes in working capital deals with the current assets and current liabilities alone,
as they are shown in the Balance Sheets of the current and the previous years. All non-current assets and non-
current liabilities, and profits and losses ignore additional information available. Each current asset and current
liability in the period’s Balance sheet is compared with that shown in the previous period’s Balance Sheet. Increase
or decrease in each of the assets and liabilities is noted. The effect of such increase or decrease during the period in
each item is recorded individually on the working capital. Finally, the overall change in the working capital is
calculated. It is possible that working capital might have increase or decrease as the final result.

The following interpretations have to be taken into consideration when schedule of changes in working capital is
prepared.

1. Increase in current assets

2. Decrease in current liabilities will result in increase in working capital.

3. Decrease in current assets

4. Increase in current liabilities will result in decrease in working capital.
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 Schedule of changes in Working Capital

Particulars End of PY End of CY Effect of Net Working Capital

Increase in WC Decrease in WC
I. Current Assets
Cash in hand/Bank xxx xxx
Marketable Securities xxx xxx
Bills Receivable xxx xxx
Sundry Debtors xxx xxx
Stock-in-trade xxx xxx
Prepaid Expenses xxx xxx
Outstanding incomes xxx xxx
Short term advances xxx xxx
xxx xxx
II. Current Liabilities
Sundry Creditors xxx xxx
Bills payable xxx xxx
Bank overdraft xxx xxx
Outstanding Expenses xxx xxx
Provision for Doubtful debts xxx xxx
Provision for Taxation* xxx xxx
Pre-received incomes xxx xxx
Cash-credit from bank xxx xxx
xxx xxx
III. Net working capital (I-II) xxx xxx xxx xxx
Increase/Decrease in WC

Note : The amounts which are put in the increase and decrease columns are hypothetical. The value of current
assets and current liabilities may increase or decrease compared to previous year. It is not necessary that items
shown in the increase and decrease columns should always give same effect.

* Treatment of Provision for Taxation : It can be treated as Current liability or as a Non-cash item (depending
upon the adjustments given in the problem)

Illustration 1
From the following details, prepare a schedule of changes in working capital

Liabilities 2018 2019 Assets 2018 2019

Share capital 1,50,000 1,50,000Goodwill 12,000 12,000
General reserve 14,000 18,000Building 40,000 36,000
Profit & Loss Account 16,000 13,000Plant 37,000 36,000
Sunday Creditors 8,000 5,400Investment 60,000 61,000
Bills Payable 1,200 800Stock 30,000 23,400
Prevision for taxation 16,000 18,000Bills receivable 2,000 3,200
Provision for doubtful debts 400 600Debtors 18,000 19,000
Cash at bank 6,600 15,200
2,05,600 2,05,800 2,05,600 2,05,800

Rules :
1. Increase in current assets
2. Decrease in current liabilities will result in increase (+) in working capital.

3. Decrease in current assets

4. Increase in current liabilities will result in decrease (-) in working capital.
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Solution : Schedule of changes in Working Capital
Particulars 2018 2019 Effect of Net Working Capital
Increase in WC Decrease in WC
I. Current Assets
Stock 30,000 23,400 - 6,600
B/R 2,000 3,200 1,200 -
Debtors 18,000 19,000 1,000 -
Cash at bank 6,600 15,200 8,600 -
56,600 60,800
II. Current Liabilities
Sunday Creditors 8,000 5,400 2,600
Bills Payable 1,200 800 400
Provision for doubtful debts 400 600 200
9,600 6,800
III. Net working Capital (I-II) 47,000 54,000 13,800 6,800
Net Increase in Working Capital 7000 7000
54,000 54,000 13,800 13,800
Note : Provision for taxation is not considered as Current Liability.

Step 2 : Funds from Operations

i. Adjusted Profit and loss Account Format (T-Form Method)

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ii. Add Back method : Funds from Operations

Statement showing Funds from Operations

Particulars Rs. Rs.

Difference in P&L a/c (Closing balance – Opening balance) Xxx
Difference in Reserves* (Closing balance – Opening balance) Xxx
Xxx
Add : Items charged to above account but do not decrease funds OR
Non-cash Items/Non-recurring expenses
Transfer to General Reserve/Specific Reserve* xxx
Goodwill / Patents written off xxx
Preliminary expenses written off xxx
Underwriting commission written-off xxx
Miscellaneous expenses xxx
Discount on issue of Debentures xxx
Depreciation xxx
Provision for depreciation xxx
Provision for Tax xxx
Interim dividend xxx
Dividend declared xxx
Premium payable on Redemption of Debentures or Preference shares xxx
Non-operating Expenses charged to P&L a/c :
Loss on sale of Investments/Fixed Assets xxx
Loss on Embezzlement xxx
Gifts given xxx
Damages paid under law suit xxx Xxx
Xxx
Less : Items which are credited to P&L a/c but result in duplication OR
Non-Operating incomes
Profit on sale of Fixed Assets xxx
Profit on revaluation of assets xxx
Dividend received or accrued xxx
Refund of Income tax xxx
Rent received or accrued xxx
Discount on Redemption of Debentures xxx Xxx
Funds from business operations Xxx

* Any one should be taken into consideration

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Important Adjustments
A. Treatment of Provision for Taxation
1. Where provision for taxation is given in the adjustment (below balance sheet) as tax paid during the year, the
following treatment should be made:
Balance Sheet

Liabilities
2018 2019
Provision for Taxation Rs. 25000 Rs. 30000
Adjustment
During the year income tax paid is Rs. 8000

Solution :
Provision for taxation Account
To Cash (To be shown in the 8000 By Balance b/d 25000
Application side of FFS - AOS)
To Balance c/d 30000 By Adjusted P&L A/c (B/F) 13000
38000 38000

2. Where provision for taxation is given in the adjustment as tax created or made, or provided, the following
treatment should be given.
Balance Sheet
Liabilities
2018 2019
Provision for Taxation Rs. 20000 Rs. 12000
Adjustment
Provision for taxation was made during the year Rs. 10, 000

Solution :
Provision for taxation Account
To cash (B/F) (To be shown in the 18000 By Balance b/d 20000
Application side of FFS - AOS)
To Balance c/d 12000 By Adjusted P&L A/c 10000
30000 30000

B. Treatment of Depreciation

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 Step 3 : Fund Flow Statement for the Year ending…..

Fund Flow Statement (In Vertical format)

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Problems on FFS

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Working Notes

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