Chapter 2.

Funds Flow Statement

 Meaning of Funds Flow Statement
Funds : According to Accounting Standard No.7, the term ‘Fund’
generally refers to cash and cash equivalents, or to working
capital.
Working Capital: There are two concepts of working capital :
gross concept and net concept. Gross working capital refers
to the firms investment in current assets, while net working
capital means excess of current assets over current
liabilities. ‘Funds’ is generally used to mean net working
capital.
Current Assets: Assets which are reasonably expected to be
realized in cash or sold or consumed during the normal
operating cycle of the business ex. Cash, accounts
receivable, inventory, advances recoverable, prepaid
expenses etc.
Current Liabilities: All obligations that will require within the
coming year or operating cycle, whichever is longer, i) the
use of existing current assets or ii) the creation of other
current liabilities ex. accounts payable, outstanding
2
 Meaning of Funds Flow Statement ( Contd)
expenses, bank overdrafts, short term loans, advance payments
received, current maturities of long-term loans etc.
Non Current Assets: All Assets other than current assets ex.
goodwill, land, building, machinery, furniture, debit balance in
P & L account etc.
Non Current Liabilities: All liabilities other than current
liabilities ex. share capital, long term loans, debentures, share
premium, credit balance in P & L account.
Flow of Funds: Any increase or decrease in working capital
means flow of funds. Flow of funds will not occur for
transactions involving only Non Current assets or liabilities or
only Current assets or liabilities. ‘Cross’ transactions
involving a fixed asset or liability and a current asset or
liability will result in a flow of funds.

3
 Preparation of the Funds Flow Statement
Sources of Funds
Internal Sources: Following adjustments need to be made to the
figure of Net Profit to calculate the funds from operations: Add
the following items that do not involve funds outflow:
i. Depreciation
ii. Preliminary expenses or goodwill etc. written off.
iii. Contribution to debenture redemption fund, transfer to general
reserve etc.
iv. Provision for taxation and proposed dividend
v. Loss on sale of Fixed Asset
Deduct the following as no funds inflow is involved :
i. Profit on sale of fixed Asset
ii. Profit on revaluation of Fixed Assets

4
 Preparation of the Funds Flow Statement
(Contd)
External Sources:
i. Funds from long term loans : e.g debentures, borrowings
from financial institutions etc.
ii. Sale of fixed assets : Sale of land, building, long-term
investments will result in generation of funds.
iii. Funds from increase in share capital : Issue of shares for
cash or any other current asset results in increase in working
capital and hence there will be flow of funds.
Application of funds:
i. Purchase of Fixed Assets: Results in decrease of current
assets without decrease in current liabilities. In case shares
or debentures are issued for acquisition of fixed assets, there
will be no flow of funds.
5
 Preparation of the Funds Flow Statement
(Contd)
ii. Payment of dividend
iii. Payment of fixed liabilities e.g redemption of debentures or
redeemable preference shares.
iv. Payment of tax liability
Schedule for changes in Working Capital: Funds flow statement
depicts changes in working capital, hence it is advisable to
prepare a schedule for changes in working capital, which can
be done by comparing current assets and current liabilities for
two periods.
Rules:
i. Increase in current assets results in increase in working
capital and vice versa
ii. Increase in current liabilities results in decrease in current
liabilities and vice versa 6
 Preparation of the Funds Flow Statement
(Contd)
Format for Schedule of changes in Working Capital
Item as on as on Change
--- --- Increase Decrease
Current Assets:
Cash
Bank Balance
Accounts receivable
Stock in trade
Prepaid expenses
Current Liabilities:
Bank Overdraft
Outstanding Expenses
Accounts payable
Net Increase/ Decrease in working capital
7
 Preparation of the Funds Flow Statement
(Contd)
Funds Flow Statement: While preparing this statement, current
assets and liabilities are to be ignored. Attention is to be given
to changes in fixed assets and fixed liabilities:
A. Sources of funds:
Issue of shares
Issue of debentures
Long term borrowings
Sale of fixed Assets
Operating Profit
B. Application of funds:
Redemption of redeemable preference shares
Redemption of debentures
Payment of other long term loans
Purchase of fixed Assets
Operating loss
Payment of dividends, tax etc.
Net Increase/ decrease in Working Capital ( A-B) 8
 Preparation of the Funds Flow Statement
(Contd)
The change in working capital disclosed by ‘the schedule of
changes in working capital’ will tally with the change in
working capital disclosed by ‘funds flow statement’.

9
 Treatment of Provision for Taxation
Provision for Taxation : There are two options available:
i. Treated as a current liability: When provision for taxation is
made, it involves P & L appropriation account, which is a
fixed liability and Provision for taxation account, which is a
current liability, resulting in a decrease in working capital. On
payment of tax, there will be no change in working capital as
it involves one current liability ( Provision for Tax) and one
current asset ( Bank or cash ).
ii. It may be taken only as an appropriation of profits: There will
be no change in working capital when the provision is made
as two fixed liabilities are involved i.e P & L appropriation
account and Provision for taxation account. However, when
taxes are paid, there is an application of funds as it involves
one fixed liability ( Provision for Tax ) and one current asset (
Bank or Cash ). 10
 Treatment of Proposed Dividends
Proposed Dividends: Can be dealt with in the similar two ways :
i. May be treated as current liability : It will appear as one of
the items decreasing working capital in the schedule for
changes in working capital. It will not be shown as
application of funds when dividend is paid later on.
ii. May be treated as an appropriation of profits : In this case,
proposed dividend for the current year will be added back to
current year’s profits in order to find out funds from
operations, if such amount of dividend has already been
charged to profits. Payment of dividends will be shown as
an ‘application of funds’.
In case no specific directions are given with regard to the
treatment of these two items, it is advised that assumptions
are clearly stated.
11
 Funds Flow Vs. Income Statement
 Deals with financial
resources required for
running the business.
Explains how funds were
obtained & used.
 Matches funds raised and
funds applied during a
particular period. The
sources and applications of
funds may be capital or
revenue in nature.
 Sources of funds are many,
besides operations such as
share capital, debentures,
sale of fixed assets etc.
 Discloses the result of
business activities i.e how
much has been earned and
how it has been spent..
 Matches incomes of a period
with the expenditure of that
period, both of which are
revenue in nature.
 An income statement which
discloses the results of
operations cannot even
accurately tell about the funds
from operations alone because
of non-fund items like
depreciation, being included
therein.
12
 Uses Of Funds Flow Statement
i. Explains the Financial consequences of business operations:
Helps the financial analyst in advising his employer / client
regarding directing of funds to those channels which will be
most profitable for the business.
ii. Acts as an instrument for allocation of resources: The funds
should be managed in such a way that the business is in a
position to make payment of interest and loan installments
as per the agreed schedule.
iii. It is a test as to the effective or otherwise use of capital: The
adequacy or inadequacy of working capital will tell the
financial analyst about the possible steps that the
management should take for effective use of surplus
working capital or make arrangements in case of
inadequacy of working capital.
13
 Summary
In this chapter you have studied :
 The meaning of Funds Flow Statement
 The transactions which involve the changes in funds
 Preparation of Funds Flow Statement
 Difference between the Funds Flow Statement and the
Income Statement
 The utility of Funds Flow Statement

14