CHAPTER I :

Indroduction

Financial statements summarizes that the financial position and operation of the company. Many
companies are used comparative, fund flow and cash flow analysis to know about the financial
position of the firm. The comparative, ratio analysis, fund flow analysis and cash flow analysis
are widely used for analyzing the financial statements. It is systematic use of ratio to interpret the
financial statements so that the strength and weaknesses of a firm is determined. During my
project the firm is not in good health and the company funds are used only for short term assets
not for long term assets.

Definition of ‘Fund Flow’

Fund flow is usually measured on a monthly or quarterly basis. The performance of an asset or
fund is not taken into account, only share redemptions (outflows) and share purchases (inflows).
Net inflows create excess cash for managers to invest, which theoretically creates demand for
securities such as stocks and bonds. Investors and market analysts watch fund flows to gauge
investor sentiment within specific asset classes, sectors, or for the market as a whole. For
instance, if net fund flows for bonds funds during a given month is negative by a large amount,
this would signal broad-based pessimism over the fixed-income markets.

A fund flow statement is a statement in summary form that indicates changes in terms of
financial position between two different balance sheet dates showing clearly the different sources
from which funds are obtained and uses to which funds are put.

It summarizes the financing and investing activities of the enterprise during an accounting
period.:

By depicting all inflows and outflows of fund, the statement shows their net impact on working
capital of the firm.

If the total of inflows is greater than the outflows, the excess goes to increase in working capital.

If there is deficit of funds during a particular accounting period, the working capital is impaired.
So fund flow statement is an important tool for working capital management.

Objectives of Fund Flow Statement:

1. Fund flow statement reveals clearly the changes in items of financial position between two
different balance sheet dates showing clearly the different sources and applications of funds.
Thus, it summarizes the financing and investing activities of the enterprise.
2. It also reveals how much 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. It also provides information about the specific utilisation of such funds i.e., how much has
been used for acquiring fixed assets, how much for redemption of preference shares, debentures
or short-term loans as well as payment of tax, dividend etc.

4. It helps the management in depicting all inflows and outflows of funds which cause a change
in working capital of a business organisation.

5. The projected fund flow statement helps management to exercise budgetary control and capital
expenditure control in the enterprise.
Management uses fund flow statement for judging the financial and operating performance of the
business.

Importance of Fund Flow Statement:

1. Analyses Financial Statements:

Balance Sheet and Profit and Loss Account do not reveal the changes in the financial
position of an enterprise. Fund flow analysis shows the changes in the financial position between
two balance sheet dates. It provides details of inflow and outflow of funds i.e., sources and
application of funds during a particular period. Hence it is a significant tool in the hands of the
management for analysing the past, and for planning the future. They can infer the reasons for
imbalances in the uses of funds in the past and take corrective measures for the future.
Limitations of Fund Flow Statement:

1. Historical Nature:
The information used for the preparation of the fund flow statement is essentially historical in
nature. It does not estimate the sources and application of funds for the near future.

2. Structural Changes Not Disclosed:

The fund flow statement does not disclose the structural changes in financial relationship in a
firm. In other words, it does not reveal shifts among items making up the current assets and
current liabilities. It does not tell us whether any loss of working capital has unduly weakened
the financial position or not.

3. Not Foolproof:
The fund flow statement is prepared from the data provided in the balance sheet and profit and
loss account. Hence, the defects in financial statements will be carried over to the fund flow
statement also.

4. Ignores Non-Fund Items:

As fund flow statement ignores non-fund items, it becomes a crude device compared to income
statement and balance sheet.

5. Not Relevant:
A study of changes in cash (i.e., cash flow statement) is more relevant than a study of changes in
funds for the purpose of managerial decision-making.

Preparation of Fund Flow Statement:

Generally, two comparative balance sheets—one at the beginning and the other at
the end of the period—are used for preparing a fund flow statement. In addition, a summarised
income statement comprising non-fund or ‘non-operating’ items and a statement of retained
earnings or at least material information from these statements are required in order to find out
fund from operations.
Additional information regarding change in non-current accounts like plant and machinery,
building, share capital, debentures etc., if available, will sharpen the firms financial profile as
revealed by the fund flow statement.

The fund flow analysis involves the preparation of two statements:

(a) Statement or Schedule of Changes in Working Capital and

(b) Statement of Sources and Application of funds.

Statement or Schedule of Changes in Working Capital:

The primary purpose of a fund flow statement is to explain the net change in working capital, it
will be better to prepare first the schedule of changes in working capital before preparing a fund
flow statement.

The Schedule or Statement of changes in working capital is a statement that compares the change
in the amount of current assets and current liabilities on two balance sheet dates and highlights
its impact on working capital

Statement of Sources and Application of funds

The sources and uses of fund statement is an accounting statement that summarizes the
financial statement and financial plan. It shows the sources from which a business or a company
obtains its cash and the uses to which this cash is put during a trading period.

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Definition of ‘Cash Flow’

A cash flow statement, also known as statement of cash flows,is a financial statement that
shows how changes in balance sheet accounts and income affect cash and cash equivalents, and
breaks the analysis down to operating, investing, and financing activities. Essentially, the cash
flow statement is concerned with the flow of cash in and out of the business. As an analytical
tool, the statement of cash flows is useful in determining the short-term viability of a company,
particularly its ability to pay bills. International Accounting Standard 7 is the International
Accounting Standard that deals with cash flow statements.

Purpose

The statement of financial position is a snapshot of a firm's financial resources and

obligations at a single point in time, and the income statement summarizes a firm's financial
transactions over an interval of time. These two financial statements reflect the accrual basis
accounting used by firms to match revenues with the expenses associated with generating those
revenues. The cash flow statement includes only inflows and outflows of cash and cash
equivalents; it excludes transactions that do not directly affect cash receipts and payments. These
non-cash transactions include depreciation or write-offs on bad debts or credit losses to name a
few The cash flow statement is a cash basis report on three types of financial activities: operating
activities, investing activities, and financing activities.

Cash flow activities

The cash flow statement is partitioned into three segments, namely:

 cash flow resulting from operating activities.

 cash flow resulting from investing activities.
 cash flow resulting from financing activities.

The money coming into the business is called cash inflow, and money going out from
the business is called cash outflow.
Operating activities

Operating activities include the production, sales and delivery of the company's product as well
as collecting payment from its customers. This could include purchasing raw materials,
building inventory, advertising, and shipping the product.

Under IAS 7, operating cash flows include:

1. Receipts for the sale of loans, debt or equity instruments in a trading portfolio
2. Interest received on loans
3. Payments to suppliers for goods and services
4. Payments to employees or on behalf of employees
5. Interest payments (alternatively, this can be reported under financing activities
in IAS 7)
6. buying Merchandise

Items which are added back to [or subtracted from, as appropriate] the net income
figure (which is found on the Income Statement) to arrive at cash flows from operations
generally include:

 Depreciation (loss of tangible asset value over time)

 Deferred tax
 Amortization (loss of intangible asset value over time)
 Any gains or losses associated with the sale of a non-current asset, because
associated cash flows do not belong in the operating section (unrealized
gains/losses are also added back from the income statement).
 Dividends received general reserves

Investing activities
Examples of Investing activities are

• Purchase or Sale of an asset (assets can be land, building, equipment, marketable securities)
• Loans made to suppliers or received from customers
•Payments related to mergers and acquisition.
Financing activities

Financing activities include the inflow of cash from investors such as banks and shareholders, as
well as the outflow of cash to shareholders as dividends as the company generates income. Other
activities which impact the long-term liabilities and equity of the company are also listed in the
financing activities section of the cash flow statement.
Under IAS 7,
• Payments of dividends
• Payments for repurchase of company shares
• For non-profit organizations, receipts of donor-restricted cash that is limited to long-term
purposes

Items under the financing activities section include:

• Dividends paid
• Sale or repurchase of the company's stock
• Net borrowings
• Repayment of debt principal, including capital leases

Disclosure of non-cash activities

Under IAS 7, non-cash investing and financing activities are disclosed in footnotes to the
financial statements. Under US General Accepted Accounting Principles (GAAP), non-cash
activities may be disclosed in a footnote or within the cash flow statement itself. Non-cash
financing activities may include
 Leasing to purchase an asset
 Converting debt to equity
 Exchanging non-cash assets or liabilities for other non-cash assets or liabilities
 Issuing share
 Payment of dividend taxes in exchange for assets

Preparation methods

The direct method of preparing a cash flow statement results in a more easily understood
report. The indirect method is almost universally used, because FAS 95 requires a supplementary
report similar to the indirect method if a company chooses to use the direct method.
 Direct method

The direct method for creating a cash flow statement reports major classes of gross cash
receipts and payments. Under IAS 7, dividends received may be reported under operating
activities or under investing activities. If taxes paid are directly linked to operating activities,
they are reported under operating activities; if the taxes are directly linked to investing activities
or financing activities, they are reported under investing or financing activities. Generally
Accepted Accounting Principles (GAAP) vary from International Financial Reporting Standards
in that under GAAP rules, dividends received from a company's investing activities is reported as
an "operating activity," not an "investing activity."

Indirect method

The indirect method uses net-income as a starting point, makes adjustments for all
transactions for non-cash items, then adjusts from all cash-based transactions. An increase in an
asset account is subtracted from net income, and an increase in a liability account is added back
to net income. This method converts accrual-basis net income (or loss) into cash flow by using a
series of additions and deductions.

Rules (operating activities)

The following rules can be followed to calculate Cash Flows from Operating Activities
when given only a two-year comparative balance sheet and the Net Income figure. Cash Flows
from Operating Activities can be found by adjusting Net Income relative to the change in
beginning and ending balances of Current Assets, Current Liabilities, and sometimes Long Term
Assets. When comparing the change in long term assets over a year, the accountant must be
certain that these changes were caused entirely by their devaluation rather than purchases or sales
(i.e. they must be operating items not providing or using cash) or if they are non-operating items.

were caused entirely by their devaluation rather than purchases or sales (i.e. they must be
operating items not providing or using cash) or if they are non-operating items.

 Decrease in non-cash current assets are added to net income

 Increase in non-cash current asset are subtracted from net income
 Increase in current liabilities are added to net income
 Decrease in current liabilities are subtracted from net income
 Expenses with no cash outflows are added back to net income (depreciation
and/or amortization expense are the only operating items that have no effect on
cash flows in the period)
 Revenues with no cash inflows are subtracted from net income
 Non operating losses are added back to net income
 Non operating gains are subtracted from net income
Rules (financing activities)

Finding the Cash Flows from Financing Activities is much more intuitive and needs little
explanation. Generally, the things to account for are financing activities:

 Include as outflows, reductions of long term notes payable (as would represent the
cash repayment of debt on the balance sheet)
 Or as inflows, the issuance of new notes payable
 Include as outflows, all dividends paid by the entity to outside parties
 Or as inflows, dividend payments received from outside parties
 Include as outflows, the purchase of notes stocks or bonds
 Or as inflows, the receipt of payments on such financing vehicles.
 In the case of more advanced accounting situations, such as when dealing with
subsidiaries, the accountant must

 Exclude intra-company dividend payments.

 Exclude intra-company bond interest.