What is Fund Flow Statement? Objectives, Advantages, Limitations

What is Fund Flow Statement?

The funds-flow-statement is a report on financial operations changes, flow or movements during the period. It is a statement which shows the sources an application of funds or it shows how the activities of a business is financed in a particulate period.

Fund Flow Analysis

Two types of financial statements are prepared at the end of each financial year by business organisations: Profit and Loss (P& L) account and Balance sheet.

Profit and Loss account reveals the profit or loss sustained by the firm during the accounting year while;

Balance sheet describes the status of the company at a particular point of time. A balance sheet is composed of two sides. One side called the assets side indicates how the resources of a firm have been deployed while the second side called as the liabilities side describes its obligations.

However, both Profit and Loss account and Balance sheet suffer from a disadvantage that they both provide only a static picture of the accounts of the firm. But in a business enterprise, there is continuous flow of funds into a firm as well as out of the firm.

Hence arises a need for creating an additional statement which can show the changes in assets, liabilities and owner’s equity between two balance sheet dates. Such a statement is called a Fund Flow Statement or Statement of Sources and uses of funds.

Meaning of Funds

The term “Fund” has acquired number of meanings depending on the broadness or narrowness of the context in which it is used. One of the meanings of fund is cash and statement prepared to take only this meaning of fund into account is called as cash flow statement.

In cash flow statement, only inflow and outflow of cash is taken into account. In a broader context, fund means all financial resources be it in the form of money, men, materials etc.

However, the most widely used meaning of the term funds is working capital. Working capital means the difference between current assets and current liabilities.

Fund flow statement

Fund flow statement shows how the financial resources have been used during a particular period of time. It is, thus, a historical statement showing sources and application of funds between the two dates designed especially to analyse the changes in the financial conditions of an enterprise.

Funds Flow Statement is not an income statement. Income statement shows the items of income and expenditure of a particular period, but the Funds flow statement is an operating statement as it summaries the financial activities for a period of time. It covers all movements that involve an actual exchange of assets.

Various titles are used for this statement such as ‘Statement of sources and Application of Funds’, ‘Summary of Financial operations,’ ‘Changes in Financial Position’, ‘Fund received and Disbursed’, ‘Funds Generated and Expended’, Changes in Working Capital”, “Statement of Fund’ etc.

Title of Funds Flow Statement has been modified from time to time. Really it is very difficult to find a short time for such statement which carries much to the readers regarding its contents and functions.

A new interpretation of the term ‘funds, has now been adopted as to include assets or financial resourceful which do not flow through the working capital accounts. It seems to be the most suitable meaning fort the term ‘funds’ but the most commonly used interpretation of the term ‘funds’ is ‘working capital’

Difference between funds flow statement and balance sheet

Objectives of Fund Flow Statement

• It help in identifying the sources from where funds have been obtained as well as where have they been utilized.
• It highlights the financing pattern of the expansion of the firm.
• It pinpoints the use of debt finance in the financing structure.
• It describes the relationship between liquidity, financing, investment and dividend decision of a firm.

Advantages of Fund Flow Statement

• Fund flow statement helps in understanding the effectiveness of use of working capital.
  
  
• It helps the management of a company to define its investment policy by highlighting the changes in working capital.
  
  
• It enables the firm to evaluate its current financing pattern and take suitable corrective measures in case it finds any inadequacies.
  
  
• It assists the creditors, financial institutions and banks in understanding the financial soundness of the firm.
  
  
• Financial policies like dividend etc. are guided by fund flow statement.
  
  
• It helps one understand the effects of business operations on the financial and operational position of the firm.
  
  
• It acts as a guide to the management to maintain the working capital at the optimum level through either purchase or sale of marketable securities during the periods of adequate and inadequate working capital respectively.

Limitations of Fund Flow Statement

1. Fund flow statement lacks originality. It simply rearranges the data which exists in the financial statements in a systematic way.
   
   
2. It is historic in nature and indicates what has happened in the past and provides no estimate of the future.
   
   
3. It cannot be used on a standalone basis as it gives idea only about a change in working capital and hence has to be used with the balance sheet and profit and loss account.
   
   
4. It cannot reveal continuous changes that are happening in the financial activities of the company as it takes into consideration two particular time periods.