source: webflow

A fund flow is an important term used in business to regulate the finance of a company. It includes studying the sources of income and expenses for better stability of operation. When there is a disparity between them it causes shifts or anomalies in a company's financial situation. This requires the company to make a Fund Flow Statement.

Keep reading to learn more about its components, objectives and more.

A fund flow statement is a document created to examine the factors that led to changes in a company's financial situation between two balance sheets. Also, it depicts the inflow and outflow of money during a period, including the sources and uses of that money. A fund flow statement is also created to describe changes to a company's working capital position.

A few objectives and uses of fund flow statement include:

• Shows the Financial Position of a Company: A fund flow statement helps understand various sources and uses of funds. It also makes evident the changes in financial position between two separate balance sheet dates. Thus, it summarises the company's financing and investment activities.
• Gives Details of Total Fund Raised: It shows how much of the total funds are raised through the sale of fixed assets, issuance of shares or debentures, long-term or short-term loans, and regular company operations.
• Maintains Transparency in the Usage of Funds: It also offers details on how these funds were explicitly utilised. This includes how much was used to buy fixed assets and pay taxes, dividends, and other obligations. It also details how much was used to redeem preferred shares, debentures, or short-term loans.
• Displays Inflow and Outflow of Cash: It aids management in displaying all monetary inflows and outflows that affect an organisation's working capital.
• Helps in Management of Finances and Performance: The expected fund flow statement aids managers in exercising control over the enterprise's budget and capital expenditures. Fund flow statements are used by management to assess the company's financial and operational performance.

Fund flow statements have two components:

• Source of Funds: Include the source and where the money came from.
• Application of Funds: Signifies the use of money for both immediate and long-term needs.

To prepare a fund flow statement, an organisation have to abide by a few steps:

Step 1

Create a schedule of working capital changes. Reflect on how the current liabilities and current assets have increased or decreased. Also, note that the difference between net current assets and liabilities determines the net change in working capital.

Upsurge in Working Capital

It is considered a growth in working capital when a long-term funding source is greater than the utilisation or use of funds. This is also considering that a business may use this cash for working capital requirements. For instance, dividends or the repayment of short-term debts can both be made. As a result, operating capital will be increased in the Funds Flow Statement's "Application of Funds" section.

Slide in Working Capital

Even though a firm may need more money, it usually only has a few long-term funding sources. In such circumstances, the business will use the available funds for working capital. As a result, less money is available for working capital. In this regard, the Funds Flow Statement's "Source of Funds" section will show a drop in working capital.

Step 2

You should prepare an adjusted P&L account to determine Funds from Operations. It covers the money spent and made by the company during its normal operations, as opposed to investing and financing activities.

A few several changes a corporation makes to its annual net profit. These include non-cash expenses like amortisation and depreciation, which they add. Also, the actual fund created from operating activities is calculated after deducting any profit from the sale of investments and fixed assets.

Step 3

You must determine inflows and outflows to generate a fund flow statement. Also, to generate a fund flow statement, use the balance sheet to determine the source of funds or the direction (growing or decreasing) of its application. Lastly, to complete a statement, include any net changes in working capital and funds from operations.

Some of the importances of fund flow statements include the following:

1. Analyses of Financial Statements

The company's financial condition changes are not evident properly in the balance sheet or profit and loss account. Hence, financial position changes between two balance sheet dates demand fund flow analysis.

It gives information on the sources and uses of money within a specific period, including information about money's entrance and outflow. Therefore, it is an essential tool in the management's arsenal for looking at its past and making plans for the future. They can also extrapolate the causes of historical inequalities in using funds and take corrective action in the future.

2. Rational Dividend Policy

In some cases, a company may not have enough profit to pay dividends because of a lack of operating capital. In these situations, a fund flow statement reveals a company's working capital status and aids management in making dividend and other policy decisions.

3. Guide to Future

The projected fund flow statement can be used to determine the fund's future requirements well in advance for various objectives. As a result, prompt action might be taken to investigate different funding options.

4. Proper Allocation of Resources

The amount of money available is always capped. Therefore, it is the management's responsibility to use it appropriately. Management can then properly allocate financial resources among various projects. This is based on priority by using a predicted fund flow statement.

5. Proper Management of Working Capital

The management benefits from knowing whether working capital has been utilised to its fullest potential in corporate operations. It shows whether there is more or less operating capital than is necessary. This also aids management in finding resources for extra working capital in the event of a shortage or in making profitable use of the excess working capital.

6. Guide for Investors

Knowing whether money was wisely spent by the business is helpful to investors. Lenders can determine whether to provide money to the company based on their assessment of its creditworthiness.

7. Performance Evaluation

The management uses the fund flow statement to assess the company's operating and financial performance.

A few of the limitations of a fund flow statement include the following:

• Use of Historical Data: The data that was used to create a fund flow statement is primarily historical. Also, sources and use of finances in the short term are not estimated.
• Undisclosed Structural Changes: A fund flow statement does not show how a firm's financial relationships have changed structurally. It, therefore, does not show changes in components of current assets and liabilities. Hence, companies are unsure whether any working capital losses have unnecessarily harmed their financial position.
• Can be Flawed: A profit and loss account data and balance sheet are used to create the money flow statement. Therefore, a fund flow statement will also be affected by the flaws in financial statements.
• Ignores Non-Fund Items: Compared to balance sheets and income statements, a fund flow statement is a primitive tool as it ignores non-fund components.
• Sometimes, Irrelevant: For the objective of management decisions, a study of changes is more pertinent than an investigation of changes in funds.

Hence, it is possible to create a fund flow statement with the aid of a fund flow statement structure. The corporation creates this statement to examine how working capital has changed between the two balance sheets. It aids management in making decisions for the future. But management cannot base all decisions solely on a money flow statement because it only considers fund-based items.