FUND FLOW STATEMENT

A fund flow statement is a summary of a firm's inflow and outflow of funds. It tells us from where funds have come and where funds have gone. Fund flows statement can indicate whether sourcing of funds and their use match in ALM sense and also reveal the prudence or otherwise of a firm's financing and investment decisions.

A firm's balance sheet
From a bank's perspective a borrower's balance sheet can be seen as a structure of five boxes as below.

We can observe the following from above figure:

• Owner's fund and long term loans represent long term sources of funds
• Current liabilities (including short term loans repayable within one year) represents short term sources of capital.
• Thee whole of long term funds is not invested in long term assets but a portion of it is invested in short term or current assets as well. The extent by which current assets are financed by long term funds is known as net working capital or NWC.

If we convert balance sheets of two consecutive years into boxes as above and work out the change in amounts in the boxes, we will get a fund flow statement as below.

Therefore, preparation of fund flow statement involves the followings steps:

• Take balance sheets as at two dates covering the period for which fund flows statement is intended to be prepared.
• Work out increase /decrease in each of items
• Classify change in each item under any of the four heads: (1) Long term sources (2) Long term uses (3) Short term sources (4) Short term uses. The deficit or the surplus in the long term category will be equal to the surplus or deficit in the short term category.

Preparing fund flow statement
Generally changes in assets and liabilities lead to inflows or outflows of cash (or funds). Increase in assets or liabilities, however does not always lead to flow of funds, for instance, depreciation or any kind of revaluation. Therefore, all increases/decreases in asset or liabilities will not form part of fund flow statement but only those that result in the flows of funds.  The following table encapsulates the fund flow implications of changes in asset/liabilities values.

When preparing fund flow statement we have to nullify the non-fund based adjustments in order to capture only those changes in the values of assets and liabilities that are accompanied by flows of fund. Increase in the item "reserves and surplus" indicate the amount of retained profits for the year. If we add profits distributed to this figure we will get the amount of net profit for the year after taxes. We need to adjust the net profit figure for all non-cash expenses and non-cash incomes. As a rule, we have to add all non-cash expenditure to and deduct all non-cash income from the figure of net profit. For depreciation in assets: Add depreciation to the change in reserve and surplus and correspondingly to the value of assets concerned. The opposite holds for appreciation. For write offs: Add the amount of write offs to net profits.

Income accrued but received and expenses incurred but not received reckoned in the profit and loss account should not be excluded from the profit figure for the purpose of Fund Flow Statement. The rationale for this rule is that so long as accrued incomes are expected to be received and outstanding expenses are expected to be paid in the normal course of business there is no harm in treating these as inflow or outflow of funds, albeit with a lag.

As regards changes in items of current assets and liabilities, we can either show the items separately or net them to arrive at the figure of "change in net working capital". It is however more informative to show the current items separately.

The following example illustrates the preparation of fund flow statement.

The first step in working out fund flows is to compute the changes in assets and liabilities during 2006-07. This is shown in the following table.

Note that increase in assets is use of funds (outflows) while decrease in assets is source of funds (inflows) and so forth as shown in Table-1. Further, depending on which 'box' (see Figure 2) the items belong the change can represent either a long term or short term source/use. Accordingly, the changes have been categorized as LTS, LTU, STS, STU in the table above. This is our skeleton fund flow statement. We now have to nullify the impact of non-fund based adjustments hidden in the above numbers. Also, certain adjustments are made just in order to make a more meaningful presentation. For example, we are told that the proprietor has withdrawn Rs.50,00,000 from Capital A/c. The withdrawal is fund-based adjustment not requiring any adjustment, strictly speaking. But according to our skeleton fund flow statement increase in reserve and surplus (that is, profit for the year) is Rs.15,00,000. This figure is obviously after the withdrawal of Rs.50,000. The true profit is not therefore Rs.15,00,000 but Rs.65,000. Therefore, a better presentation would be to show profit from operations as Rs.65,00,000 on the Source side and Rs.15,00,000 as profits withdrawn on Uses side. This is arithmetically same as showing just Rs.15,00,000 on the Source side. Therefore our adjustment is as under:

Profit from operations Rs.lakh

Increase in reserves and surplus:15

Add: Profit withdrawn 50

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Total 65

Provision for tax does not require any adjustment as even though a mere provision does entail fund flow as tax will have to be paid anyway; it is just a matter of timing.

Finally, the increase in fixed assets shown as Rs.86,000 in Table 3, does not represent the correct figure of fixed assets purchased as the fixed assets values include the effect of depreciation. We will have to nullify that.
Rs.lakh
Depreciation provision as on 31.3.2007-129
Depreciation provision as on 31.3.2006-90
Depreciation provided in 2006-07-39

Profit before depreciation adjustment-65
Add depreciation (non-cash expense)-39
Correct cash profit (LT source of funds)-104

Balance of fixed assets as at 31.3.20072-21
Add: depreciation for 2006-07-39
Balance of fixed asset as at 31.3.07 before depreciation-260
Less: Balance of fixed asset as at 31.3.2006-135
Fixed assets purchased during 06-07 (LT application of funds)-125

Fund Flow Statement

How do we interpret the above fund flow statement? Basically, it shows healthy cash flows from operations. However the problem is that the firm is using short term money to finance long term investments. This can lead to liquidity problems in future. The onset of liquidity problems is visible as the firm has increased current assets by Rs.33 lakhs as compared with increase in current liabilities by Rs.100 lakh, which produces incremental current ratio of 0.33. Also, the promoter has withdrawn nearly half the profit, which is serious imprudence when he had plans to invest heavily in fixed assets. From another angle, it can be argued that the promoter has withdrawn the more than the entire bank loan. Prima facie, this also appears to be a case of diversion of funds.

In this manner a fund flow statement can be used to derive valuable information on the manner in which a firm raises and deploys its funds.

Revised  by Shri  Arnab Kumar Chowdhury, DGM and Member of Faculty, CAB,Pune (March 2007)