What Is Flow of Fund?

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WHAT IS FLOW OF FUND?

Different users of financial statement may interpret the term


fund differently. The term fund can possibly have four different
interpretations;
• The funds refers to all resources held by the firm, long-term
and short-term.
• Funds mean current assets.
• The fund is also known as the difference of current assets
and current liabilities, i.e., net working capital and
• Funds as cash only.
All these definitions are correct from different perspectives but
when be are talking of flow of funds the definition of the word
change.
Refer to the arrow which indicates the flow of fund.
Current Assets Fixed Assets
Cash in Hand Building
Cash at Bank Land
Debtors Plant and Machinery
Bills Receivable Furniture
Advances Investment
Accrued Income Goodwill
 
Current Liabilities Fixed Liabilities and Capital
Bills Payable Share capital
Creditors Debenture
Bank Overdraft Long-term Loans
Outstanding Expenses Profits
Doubtful Debts Reserve
Provision for Bed Debts
Current Assets:

The current assets are normally converted into cash within an


accounting period. This accounting period is generally not more
than one year. It can consist of:
• Cash and Bank Balance
• Advance Payment of Tax
• Income tax paid under dispute
• Loans and advance
• Non-trade marketable securities or readily saleable
securities or short-term investment or investment in treasury
bills, etc.
• Prepaid expenses
• Account receivable ( bills receivable + debtors)
• Inventories (raw materials + work in progress – finished goods)
Current Liabilities:
The current liabilities are those liabilities which are
paid within an accounting year out of current assets
or by creating new current liabilities. It can consist of:

• Account Payable
• Bank Overdraft
• Outstanding Expenses
• Unclaimed Dividend
• Proposed Dividend
• Provision for Taxation
Transaction which do not effect working capital

1. Fixed assets and fixed liabilities: when both aspects of a


transaction are fixed , there is no flow of funds; e.g.,
when a company procures fixed assets and issues shares
to make the payment.
2. Current assets and current liabilities: When both
transaction are current in nature it does not affect
flow of funds example when a company receives
payment from its debtors.
Funds Flow
The change in the net working capital due to new
transaction between two dates is known as the flow
of funds. The direction of the flow of funds may result
either in the increase in the working capital or in the
decrease in the working capital.
There will be either inflow or outflow of funds if the
transaction is between the following:
(i)     Equities versus current assets.
(ii)    Equities versus current liabilities.
(iii)   Fixed assets versus non-fixed assets.
(iv)   Fixed assets versus current liabilities.
Transaction where funds inflow is
equal to funds outflow
This point where working capital neither increases nor
decreases. It can be described as follows:
(i)      Redemption of debenture by converting them
into new debentures.
(ii)     Payment of long-term debt or debentures by creating
new long-term debts.
(iii)    Exchange of one-fixed assets by another fixed asset /
fixed investment.
(iv)  Issuing share or debentures for purchasing the fixed
Assets.
(v)     Bank overdraft taken to repay the creditors.
LIMITATION OF FUNDS FLOW STATEMENT

The fund flow statement may mislead the users if the assets
and liabilities are either overvalued or undervalued moreover.
f adequate depreciation is not charged on the assets.
(i)   The current cost of the assets is not considered:
The funds flow statement is prepared with the help on
the balance sheets of two periods and the profit and
loss account of the current period. These statements
are based on the historical cost. The current cost is not
considered for the purpose of preparation of the
funds flow statement. Therefore , the realistic comparison of
profitability and the funds position is not possible.
(ii)  Does not reveal the cash position of the concern:
The cash position of the concern is not revealed by
funds flow statement. An additional statement named
as cash flow statement has to be prepared to know the
cash position of the business.
(iii) Does not classify the various activities of the concern:
The various activities are not classified as operating
activities, investing activities and financing activities
while preparing funds flow statement.
The limitations attached to the financial statement are
also the limitations of the funds flow statement because
it is prepared on the basis of the final accounts. The final
accounts are normally prepared on the basis of historical
accounting. The limitation attached to financial statements
are as follows:
(i) Different method are used the charge depreciation.
(ii)     Different method ate used to value the closing stock
of inventory.
(iii)    The effect of inflation is not considered while
preparing the financial statement.
PROCESS OF THE PREPARING
FUNDS FLOW STATEMENTS

The first steps preparation of funds flow statement is


to find out the change in working capital between the
two years, which can be calculated by preparing a
statement of changes in working capital, which is as
follows:
Rules of preparing statement of working capital

To summarize the whole discussion, we should remember


the following rules:
1. An increase in current assets increases working capital.
2.  A decrease in current assets decreases working capital.
3.  An increase in current liabilities decreases working capital.
4.  A decrease in current liabilities increases working capital.

n the 2nd steps of the preparation of fund flow statement,


we have to calculate funds from operation, which can be
calculated as follow:
Calculation of funds from operation

Net profit for the current year


Add: Non-2nd item and Non-trading charges already debited
to profit and loss A/c.
Depreciation
Preliminary expenses written-off
Goodwill, Patents written-off
Discount on issue of debenture written-off
Premium on redemption written-off
Proposed Dividend
Transfer to General Reserve
Transfer to Sinking Fund
Advertising expenses written-off
Loss on sale of fixed assets
Calculation of funds from operation

Loss: Dividend Received or Receivable


Profit on sale of Fixed Assets
Rent Received
Income from any other non-operating activity

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