Funds Flow Analysis, Cash Flow Statement and its Interpretation

FUNDS FLOW ANALYSIS

Fund flow is the net of all cash inflows and outflows in and out of various financial assets. 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, or outflows, and share purchases, or inflows. Net inflows create excess cash for managers to invest, which theoretically creates demand for securities such as stocks and bonds.

Generally speaking, the Fund Flow analysis requires the preparation of two statements:-  

1. Statement of Changes in Working Capital
2. Fund Flow Statement. 
3. Statement of Changes in Working Capital:

The working capital does change due to various transactions. The working capital position at the beginning of a period is changed to a different position at the end of that period. A Statement of working capital is prepared to depict the changes in working capital. Working capital represents the excess of Current Assets over Current Liabilities.

Since, several items i.e. all current assets and current liabilities are the component of working capital, it is necessary to measure the increase or decrease therein, by preparing a Statement or Schedule of changes in Working Capital. This Statement is prepared with current assets and current liabilities as appearing in the Balance Sheets under consideration.

The Statement shows the changes in individual items of current assets and current liabilities and their effect of working capital. The total increase and the total decrease in the end is compared and the difference of total increase and total decrease shows the net increase or net decrease in the working capital.

Steps:

1. The amount of every item of Current Asset of the current year is compared with its amount of previous year. If the amount of current asset of the current year is more than its amount of previous year, the excess is recorded in debit column.
2. If the amount of current asset of the current year is less than its amount of the previous year, the deficiency is recorded in credit column.
3. Make sure that all the accounts relating to current assets appearing in the two Balance Sheets are gone through and differences are properly recorded.
4. If the amount of each current liability of current year is more than its amount of previous year, the excess is recorded in the credit column.
5. If the amount of current liability of current year is less than its amount of previous year, the deficit is recorded in debit column.
6. Find out totals of all debit amounts and all credit amounts.
7. The above total are compared in the end and the difference shows decrease or increase in the Working Capital.
8. (The difference of total Current Assets and the total Current Liabilities of a year is its Working Capital.) If the Working Capital at the end of the current year is more than the Working Capital at the previous year the excess is called “Increase in Working Capital”. If previous year’s Working Capital is more than the current year’s Working Capital, the excess is called “Decrease in Working Capital”

Fund Flow Statement:

This is second but most important part of Fund Flow Statement. After preparing the Statement of Working Capital, the Statement of Sources and Application of Fund is prepared. This Statement is prepared with the help of remaining items in the Balance Sheet of the two periods all non-current assets and non-current liabilities and other information given in the problem.

That is, it is prepared on the basis of the changes in Fixed Assets, Long-term Liabilities and Share Capital ascertained on the basis of values of these items shown in the Balance Sheets. Of course, additional information, if given, must also be considered.

Thus the preparation of this Statement involves the ascertainment of increase or decrease in the various items of fixed assets, long-term liabilities and share capital. Those business transactions, which cause an increase in the working capital, are considered as Source of Fund and on the same footing business transactions causing a decrease in working capital are known as Uses of Funds.

CASH FLOW STATEMENT

A cash flow statement presents information about the cash flows associated with the company’s main operations and those associated with its investing and financing activities of the period. 

Benifits-

• To assess the ability of a firm to manage cash flows
• To assess the ability of a firm to generate cash through its operations
• To assess the company’s ability to meet its obligations and its dividend policy
• To provide information about the effectiveness of the firm to convert its revenues to cash
• To provide information to estimate or anticipate the company’s need for additional financing.

Basic cash flow activities-

(1)Operating cash flows – cash flows related to selling goods and services; that is, the principle business of the firm.

Examples-

• Receipts from sale of goods and rendering of services (cashing in of receivables included)
• Receipts from taxes on sales and VAT
• Receipts from royalties, fees, commissions,…
• Payments to suppliers (payment of creditors included)
• Payments to employees
• Payments of taxes, VAT, fines,

(2)Cash flow from investing activities- Investing activities relate to the acquisition and disposal of fixed assets and other investments.

Cash flows from investing activities are an indication of the expansion or downsizing of operating capacity.

Examples:

• Payments for newly acquired equipment
• Receipts from the disposal of a building
• Payments for new investments

(3)Cash flow from financing activities- Financing activities relate to changes in the size and composition of contributed capital and financial debt of the company

Examples:

• Receipts from issuing new shares or bonds
• Receipts from new bank loan
• Payments for buy-back of shares
• Repayments of loans
• Payments of interest and dividend