Introduction to Cash Flow Statement and Fund Flow Statement

In accounting and financial management, it is not enough for a business to know only its profit or the value of its assets and liabilities. A business must also understand how money and financial resources move within the organization. Many businesses may show a good profit in the Profit and Loss Account and still face difficulties in paying salaries, suppliers, loan installments, or day-to-day expenses because they do not have enough cash at the right time. Similarly, a business may have enough working capital at one point and then experience changes in its financial position due to expansion, borrowing, repayment, or changes in current assets and current liabilities. To understand such movements, accountants prepare Cash Flow Statements and Fund Flow Statements.

A Cash Flow Statement shows the movement of cash and cash equivalents during an accounting period. It explains how cash was generated and how it was used in operating, investing, and financing activities. On the other hand, a Fund Flow Statement shows the movement of funds, generally in terms of working capital, between two balance sheet dates. It explains the sources from which funds were obtained and the ways in which those funds were applied.

Both statements are important tools of financial analysis. They help management, investors, creditors, bankers, and other stakeholders understand the liquidity, financial flexibility, and resource management of the business. Although both deal with the movement of financial resources, they differ in scope, focus, and method of preparation. A proper understanding of both statements is essential for students of commerce, accountants, and business managers.

Part I: Cash Flow Statement

Meaning of Cash Flow Statement

A Cash Flow Statement is a financial statement that shows the inflow and outflow of cash and cash equivalents during a particular accounting period. It explains how the cash balance of the business changed from the beginning of the year to the end of the year.

Cash flow statement focuses only on cash transactions. It does not include non-cash items such as depreciation, goodwill written off, or transfer entries unless they affect cash indirectly. It helps answer questions such as:

How much cash was generated from business operations?
How much cash was used to purchase fixed assets?
How much cash was received from loans or issue of shares?
Why did the cash balance increase or decrease during the year?

Thus, the cash flow statement presents a clear picture of the liquidity position of the business and the actual cash generated and used during the year.

Definition of Cash Flow Statement

A cash flow statement may be defined as a statement showing the sources and uses of cash and cash equivalents during an accounting period, classified into operating activities, investing activities, and financing activities.

This definition makes it clear that the statement is not merely a summary of cash receipts and cash payments; it is a classified presentation of cash movements according to the nature of activities.

Objectives of Cash Flow Statement

The main objective of preparing a cash flow statement is to provide information about the cash inflows and cash outflows of a business during a period. It helps users know whether the business is generating sufficient cash from its operations and how it is utilizing that cash.

Another objective is to assess the liquidity and solvency of the business. Even if a business earns profit, it may still face liquidity problems if cash is tied up in debtors, stock, or fixed assets. The cash flow statement helps identify such situations.

It also helps in evaluating the ability of the business to pay dividends, repay loans, purchase fixed assets, and meet day-to-day obligations. Management can use this information for cash budgeting, financial planning, and decision-making.

For investors and creditors, the cash flow statement provides valuable information about the financial flexibility and cash-generating capacity of the business.

Importance of Cash Flow Statement

The cash flow statement is extremely important because it provides information that is not available from the Profit and Loss Account or Balance Sheet alone. The Profit and Loss Account is prepared on an accrual basis and may show profit even when cash has not actually been received. Similarly, the Balance Sheet shows the financial position at a particular date but does not explain how the cash position changed during the year.

The cash flow statement fills this gap by showing the actual movement of cash. It helps in evaluating whether the business can meet its short-term obligations, maintain operations, and finance growth without facing cash shortages.

It is also useful in comparing the cash management performance of different businesses or the same business over different years. Banks and lenders often examine the cash flow statement before granting loans because it shows the business’s ability to generate cash for repayment.

Cash and Cash Equivalents

Before understanding the cash flow statement, it is important to know the meaning of cash and cash equivalents.

Cash includes cash in hand and demand deposits with banks.
Cash equivalents are short-term, highly liquid investments that can be easily converted into known amounts of cash and have a very short maturity period, usually three months or less. Examples include treasury bills, commercial paper, and short-term bank deposits.

The cash flow statement therefore covers both cash and cash equivalents.

Classification of Cash Flows

Cash flows are classified into three main categories:

1. Cash Flow from Operating Activities

Operating activities are the principal revenue-generating activities of the business. These are the activities related to the normal operations of the business, such as buying goods, selling goods, paying wages, paying rent, receiving cash from customers, and paying suppliers.

Examples of cash inflows from operating activities:

Cash received from customers
Cash receipts from service revenue
Cash received from royalties, fees, or commissions

Examples of cash outflows from operating activities:

Cash paid to suppliers
Cash paid to employees
Cash paid for rent, electricity, and other operating expenses
Cash paid for taxes

Cash flow from operating activities is very important because it shows whether the business is able to generate enough cash from its normal operations.

2. Cash Flow from Investing Activities

Investing activities relate to the acquisition and disposal of long-term assets and investments. These activities generally affect the future earning capacity of the business.

Examples of cash inflows from investing activities:

Sale of machinery, furniture, or building
Sale of investments
Interest or dividend received on investments (depending on accounting treatment)

Examples of cash outflows from investing activities:

Purchase of machinery, land, building, or equipment
Purchase of investments
Loans given to other parties

Investing activities often involve large cash outflows because businesses invest in fixed assets for future growth.

3. Cash Flow from Financing Activities

Financing activities are activities that result in changes in the size and composition of the owner’s capital and borrowings of the business.

Examples of cash inflows from financing activities:

Issue of shares
Issue of debentures
Raising long-term loans from banks or financial institutions

Examples of cash outflows from financing activities:

Repayment of bank loans
Redemption of debentures
Payment of dividends
Interest paid in some cases, depending on classification

Cash flow from financing activities shows how the business is financing its operations and investments.

Methods of Preparing Cash Flow Statement

Cash flow from operating activities can be prepared by two methods:

1. Direct Method

Under the direct method, major classes of gross cash receipts and cash payments are shown separately. It directly presents cash received from customers and cash paid for operating expenses.

For example:

Cash received from customers
Cash paid to suppliers
Cash paid to employees
Cash paid for operating expenses

This method provides a detailed view of actual operating cash flows.

2. Indirect Method

Under the indirect method, net profit is adjusted for non-cash items, non-operating items, and changes in working capital to arrive at cash flow from operating activities.

The process generally involves:

Starting with net profit before tax
Adding non-cash expenses such as depreciation
Subtracting non-operating incomes such as profit on sale of assets
Adjusting for changes in current assets and current liabilities

The indirect method is more commonly used in practice.

Format of Cash Flow Statement

A Cash Flow Statement is generally prepared in the following form:

Cash Flow Statement for the Year Ended ………

A. Cash Flow from Operating Activities
Net Profit before tax
Add: Non-cash expenses (Depreciation, etc.)
Less: Non-operating incomes
Adjust for changes in working capital
= Net Cash from Operating Activities

B. Cash Flow from Investing Activities
Sale of fixed assets
Sale of investments
Less: Purchase of fixed assets
Less: Purchase of investments
= Net Cash used in Investing Activities

C. Cash Flow from Financing Activities
Issue of shares
Issue of debentures
Loan raised
Less: Repayment of loans
Less: Dividend paid
= Net Cash from Financing Activities

Net Increase / Decrease in Cash and Cash Equivalents
Add: Opening Cash and Cash Equivalents
= Closing Cash and Cash Equivalents

Practical Example of Cash Flow Statement

Suppose a company has the following information:

Net Profit before tax = ₹80,000
Depreciation = ₹10,000
Increase in Debtors = ₹5,000
Increase in Creditors = ₹3,000
Purchase of Machinery = ₹25,000
Issue of Shares = ₹40,000
Opening Cash Balance = ₹20,000

Step 1: Cash Flow from Operating Activities

Net Profit before tax = ₹80,000
Add Depreciation = ₹10,000
Less Increase in Debtors = ₹5,000
Add Increase in Creditors = ₹3,000

Net Cash from Operating Activities = ₹88,000

Step 2: Cash Flow from Investing Activities

Purchase of Machinery = ₹25,000 outflow

Net Cash used in Investing Activities = (₹25,000)

Step 3: Cash Flow from Financing Activities

Issue of Shares = ₹40,000 inflow

Net Cash from Financing Activities = ₹40,000

Step 4: Net Change in Cash

Net Increase in Cash = ₹88,000 − ₹25,000 + ₹40,000 = ₹1,03,000

Add Opening Cash = ₹20,000

Closing Cash Balance = ₹1,23,000

This example shows how cash generated from operations, investing, and financing activities affects the final cash balance.

Advantages of Cash Flow Statement

The cash flow statement offers many advantages. It helps in assessing the liquidity and solvency of the business. It shows whether operations are generating sufficient cash. It helps management in planning future cash requirements and avoiding cash shortages.

It is also useful for investors and creditors because it shows the actual cash-generating capacity of the business. It improves the understanding of financial statements and provides better information for decision-making.

Limitations of Cash Flow Statement

Despite its usefulness, the cash flow statement also has limitations. It focuses only on cash transactions and ignores non-cash items, even though such items may be important for understanding overall profitability. It also does not directly show the net profit of the business. Furthermore, a cash flow statement for one year may not be enough to judge long-term financial performance without comparing multiple years.

Part II: Fund Flow Statement

Meaning of Fund Flow Statement

A Fund Flow Statement is a statement showing the movement of funds between two balance sheet dates. In traditional financial analysis, the word fund usually means working capital, that is, the excess of current assets over current liabilities.

Thus, a fund flow statement explains how the working capital position of the business has changed during a particular period. It shows the sources of funds and applications (uses) of funds.

While the cash flow statement focuses only on cash and cash equivalents, the fund flow statement takes a broader view by analyzing changes in working capital and long-term financial resources.

Definition of Fund Flow Statement

A fund flow statement may be defined as a statement prepared to show the sources and application of funds between two balance sheet dates, indicating the reasons for changes in the financial position of the business.

This statement helps explain how funds were generated and where they were used during the year.

Objectives of Fund Flow Statement

The main objective of the fund flow statement is to analyze changes in the working capital of the business. It helps management understand where the funds came from and how they were used.

Another objective is to evaluate the long-term financing and investment decisions of the business. It shows whether funds were obtained from operations, issue of shares, sale of fixed assets, or long-term borrowings, and whether they were used for purchasing fixed assets, repaying loans, or paying dividends.

The fund flow statement also helps in financial planning, capital budgeting, and control over working capital. It gives a broader picture of financial changes than the cash flow statement in terms of resource movement.

Importance of Fund Flow Statement

Fund flow statement is important because it helps in understanding the changes in the financial structure of the business between two accounting dates. It explains why working capital increased or decreased and how long-term funds were raised and used.

It is useful for management in planning future financing needs, controlling working capital, and evaluating the consequences of business decisions such as expansion, borrowing, and repayment. It also helps lenders and analysts understand the movement of financial resources over a period.

Sources of Funds

Common sources of funds in a fund flow statement include:

Funds from operations
Issue of shares
Issue of debentures
Long-term loans raised
Sale of fixed assets
Sale of investments
Non-trading receipts if treated as long-term funds

Applications of Funds

Common applications or uses of funds include:

Purchase of fixed assets
Purchase of long-term investments
Redemption of debentures
Repayment of long-term loans
Payment of dividends
Payment of tax if treated as appropriation
Increase in working capital

Funds from Operations

One of the most important sources in a fund flow statement is funds from operations. It represents the funds generated from normal business operations. It is calculated by adjusting net profit for non-fund and non-operating items.

Generally, the following are added back to net profit:

Depreciation
Goodwill written off
Preliminary expenses written off
Loss on sale of fixed assets

The following are deducted:

Profit on sale of fixed assets
Non-operating incomes credited to Profit and Loss Account

The resulting figure is known as funds from operations.

Statement of Changes in Working Capital

Before preparing the fund flow statement, a statement of changes in working capital is prepared. This statement compares current assets and current liabilities of two balance sheet dates and shows whether working capital has increased or decreased.

Increase in current assets increases working capital.
Increase in current liabilities decreases working capital.
Decrease in current assets decreases working capital.
Decrease in current liabilities increases working capital.

The net effect of these changes determines the increase or decrease in working capital.

Format of Fund Flow Statement

Fund Flow Statement for the Year Ended ………

Sources of Funds

Funds from operations
Issue of share capital
Issue of debentures
Long-term borrowings
Sale of fixed assets
Sale of investments

Application of Funds

Purchase of fixed assets
Purchase of investments
Redemption of debentures
Repayment of long-term loans
Payment of dividends
Payment of tax
Increase in working capital

If the applications exceed sources, the balancing figure may represent decrease in working capital.

Practical Example of Fund Flow Statement

Suppose a business has the following information:

Funds from operations = ₹1,20,000
Issue of shares = ₹50,000
Sale of machinery = ₹20,000
Purchase of furniture = ₹60,000
Repayment of bank loan = ₹40,000
Dividend paid = ₹20,000
Increase in working capital = balancing figure

Total Sources of Funds

Funds from operations = ₹1,20,000
Issue of shares = ₹50,000
Sale of machinery = ₹20,000

Total Sources = ₹1,90,000

Total Application of Funds

Purchase of furniture = ₹60,000
Repayment of bank loan = ₹40,000
Dividend paid = ₹20,000

Subtotal = ₹1,20,000

Balancing figure = Increase in Working Capital = ₹70,000

Thus, the business generated ₹1,90,000 of funds, of which ₹1,20,000 was used for specific long-term purposes and the remaining ₹70,000 increased working capital.

Advantages of Fund Flow Statement

Fund flow statement helps in understanding the financial strategy of the business. It shows how long-term funds were raised and how they were applied. It helps management in planning working capital requirements and evaluating financial decisions. It is also useful in studying the relationship between profitability and working capital changes.

Limitations of Fund Flow Statement

The fund flow statement also has limitations. It does not focus specifically on cash and may therefore not reveal immediate liquidity problems. It is based on the concept of working capital, which may not always be sufficient for modern cash management needs. It is also less commonly used today compared to the cash flow statement, which has become more important under modern accounting standards.

Difference between Cash Flow Statement and Fund Flow Statement

Although both statements deal with financial movements, they differ in several important respects.

A Cash Flow Statement shows the movement of cash and cash equivalents during an accounting period, whereas a Fund Flow Statement shows the movement of funds or working capital between two balance sheet dates.

The cash flow statement focuses on cash receipts and cash payments, while the fund flow statement focuses on sources and applications of funds and changes in working capital.

Cash flow statement is more useful for analyzing short-term liquidity and cash management, whereas fund flow statement is more useful for analyzing overall financial changes and working capital movements.

Cash flow statement is generally prepared according to accounting standards and is widely used in modern financial reporting, whereas fund flow statement is more traditional and is mainly used for managerial and analytical purposes.

Similarities between Cash Flow Statement and Fund Flow Statement

Despite their differences, both statements are important tools of financial analysis. Both help in understanding the movement of financial resources and the financial position of the business. Both assist management, investors, and creditors in decision-making. Both are prepared from accounting records and help explain changes between two accounting dates.

Conclusion

The Cash Flow Statement and Fund Flow Statement are important statements used to analyze the financial movement and resource management of a business. The cash flow statement shows the inflow and outflow of cash and cash equivalents under operating, investing, and financing activities, while the fund flow statement shows the sources and application of funds, usually in terms of changes in working capital.

The cash flow statement is especially useful for understanding liquidity, cash management, and the ability of the business to meet immediate obligations. The fund flow statement, on the other hand, helps in understanding broader financial changes, working capital movements, and long-term financial decisions. Together, these statements provide a deeper understanding of the financial structure and financial behavior of a business beyond what the Profit and Loss Account and Balance Sheet alone can show.

A clear understanding of cash flow and fund flow statements is therefore essential for students of commerce, accountants, financial managers, investors, and all those who wish to analyze the real financial strength and cash-generating capacity of a business.

Cash Flow Statement and Fund Flow Statement