Key Highlights
- A fund flow statement is a document that covers the inflows and outflows of funds.
- The funding sources and the use of funds in a given period will be included.
- Therefore, the reasons behind the change in a company's finances can be analysed.
Understanding Fund Flow Statement
To verify the transfer of funds from the previous financial year to the current financial year, a Funds Flow Statement is a financial document which analyses a company's balance sheet for two years. It will assess the source of inflows and outflows during the relevant accounting period, as well as analyse their impact on the working capital of an organisation.
It is one of the critical indicators that shows how funds are used. Finance analysts will be able to evaluate the fund flow of an organisation in due course under this statement. It is also known as the application of the Funds and the Statement of Sources, as this statement describes the movement of funds between different sources and their applications.
The preparation of these statements usually follows an analysis of the flows of funds. As a financial instrument, it helps companies manage their finances and better account for the use of funds.
What is the Fund Flow Statement Analysis?
Fund flow statement analysis is often used to understand changes in a company's financial situation. Like cash flow statement analysis, fund flow statement analysis examines financial information, including the balance sheet and income of the business. The majority of companies use a mix of three main accounting statements to analyse their finances and operations.
1. Balance sheet
All the assets, liabilities and capital accounts are summarised with their current balances reflecting a specific period.
2. Profit and Loss Statement Income Statement
The profit and loss or income statement summarises the revenue, costs and profit or loss for a given period.
3. Cash flow statement
For a specific time, cash inflows and outflows from operating activities, investment activities or financial activities will be assessed by examining cash inflows and outflows, which are most comparable to the Fund Flow Statement.
Objectives of Fund Flow Statement
The primary objectives of the fund flow statement are as follows.
1. An analysis of the company's operating situation
The balance sheet provides an overview of the company's finances constantly. This report provides an overview of the company's situation at any given time. Hence, it is essential to undertake a detailed examination of funds movements to improve corporate finance planning.
2. Help to inform the company of changes in its financial position
A statement of reasons for changing the assets, liabilities or equity capital shall be essential in preparing a Fund Flow Statement. This is based on comparing the two balance sheets for different accounting periods.
3. Help to allocate the resources in a proper manner
To make more efficient and effective use of resources, the financial flow declaration helps provide information on resource allocation. It also includes information on the source of financing from abroad and internal sources.
4. To assess whether or not the company is financially stable
Fund flow statements are required to determine the strengths and weaknesses of the company's external and internal users of the financial statements.
5. The future guidance will be the fund flow statement
The fund flow statement shall reflect all details relating to the historical changes in the company's working capital and assets in a particular accounting period. Therefore, it is an instrument for making budgetary decisions to meet the organisation's objectives.
Importance of Fund Flow Statement
The importance of the fund flow statement is as follows.
1. Financial situation
The reasons for a company's financial position change are not explained by its profit and loss statement or balance sheet. The statement will provide details regarding the source of the cash and the application of the funds.
2. Company Analysis
In cash crunch scenarios, most companies that make profits end up on the wrong side. The Fund Flow Statement will provide a clear picture of the source and use of funds under these scenarios.
3. Management
The statement of financial flows is a tool for management to determine its course of action, and also plays an administrative control role.
4. Changes in assets and liabilities
Between the two balance sheet dates, the statement shows the reason for the change in assets and liabilities. Therefore, an in-depth analysis of the balance sheet can be performed.
5. Creditworthiness
This company statement is used by lending institutions to assess its creditworthiness. The statements are compared against each other over several years to approve a loan. As a result, the statement shows the company's credibility as a fund manager.
How to Prepare Fund Flow Statement?
An organisation must take several steps to prepare a financial flow statement, as mentioned below.
Step 1
A schedule of working capital changes will be created. Consider how the current liabilities and existing assets have changed over time. In addition, note that the difference between current assets and liabilities determines net working capital change.
Step 2
To determine the Funds from Operations, you should prepare an adjusted P&L account. This relates to the amounts a company spends and earns in its regular business course rather than investment or financing activities. Several adjustments to the corporation's annual profit are made. They add noncash costs such as amortisation and depreciation. After the deduction of any gain on the sale of investments and fixed assets, the actual funds generated from operating activities will also be calculated.
Step 3
You must specify inflows and outflows to create a flow statement on the fund. The balance sheet should also be used to determine the source of funds or directional growth or contraction of its use to generate a fund flow statement. Any net change in working capital or funds from operations will also be included when the information is completed.
How Does Fund Flow Analysis Help Investors?
In assessing whether a company can manage funds properly, the Fund Flow Analysis can be an excellent tool for prospective investors. Investors will then be able to estimate the company's creditworthiness and decide whether or not it is safe to invest in that particular company. Fund flow reports are also beneficial for the organisation's management, as they help in an effective decision-making process, enabling the company to optimise its resources and ultimately maximise profits.
Limitations of Fund Flow Statement
The statement has the following limitations, although its significance for analysing a company's balance sheet is significant.
This statement is focused only on the movement of funds. Other parameters included in the balance sheet, profitability, and loss accounts are not considered. It is therefore necessary to analyse it in conjunction with the balance sheet and the profit and loss account.
The fund's flow statement does not show the company's cash position. A separate report on cash flows needs to be prepared to analyse cash position.
Conclusion
With the aid of a fund flow statement structure, it is possible to draw up a Fund Flow Statement. The company shall make a statement to assess how working capital has evolved between the two balance sheets. It provides support to management in making decisions for the future. However, since it only considers funding items, management cannot rely solely on a financial flow statement for all decisions.
