Fund = Working capital = Current assets Current liability

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1 CHAPTER 11 Fund flow statement also referred to as statement of source and application of funds presents the movement of funds and helps to understand the changes in the structure of assets, liabilities and equity capital. The usefulness of information provided by Income statement and Balance Sheet functions effectively and efficiently, but in the true sense they do not disclose the nature of all transactions. Management, Creditors and Investors etc. want to determine or evaluate the sources and application of funds employed by the firm for the future course of action. Therefore, it is essential to analyse the movement of assets, liabilities, funds from operations and capital between the components of two year financial statements. The information required for the preparation of funds flow statement is drawn from the basic financial statements such as the Balance Sheet and statement of profit and loss.the most commonly accepted form of fund flow is the one prepared on working capital basis. Meaning of Fund Fund means working capital. If current assets of company is more than current liability of business, it is called working capital and working capital s other name is Fund. Fund = Working capital = Current assets Current liability Meaning of Flow of Funds Flow of funds include both inflow and outflow. The term flow of funds means Transfer of economic values from one assets to another and one liability to another. Flow of fund takes place whenever there is change in working capital. This change may be either inflow or outflow of funds. If fixed assets are converted into current asset or fixed liability is converted into current liabilities, these are the flow of fund. But if current assets are changed with other current assets or current Liabilities are changed into other current liabilities, then, there is no flow of fund because there is no change working capital.suppose, we get the money from debtor, this is not flow of fund because, working capital is not changed. Both items of current assets and when current assets change into current assets, there will not be change in working capital. Flow of Fund = Fixed asset changes into current asset or current asset changes into fixed assets Or Fixed liability changes into current liability or current liability changes into fixed liability. Or Any transaction which attract one current account and one non-current account then it is only flow of fund. For example: 1

2 Machinery a/c (Non-current) To share capital a/c (Non-current) (Machinery purchase in consideration of share) In the above transaction both accounts are non current accounts which do not affect working capital and same will remain unaffected i.e. there will be no flow of fund. Machinery a/c (Non-current) To Bank a/c (Current) (Machinery purchase in cash) In the above transaction one account is non-current and other is current which effect working capital i.e. there will be flow of fund. There are a few examples of inflow and outflow of funds: Inflow of Funds Issue of Equity Share Capital Issue of Preference Share Capital Issue of Debentures/Long term Loans Premium on issue of shares/debentures Sale of Investments Sale of Fixed Assets Outflow of Funds Redemption of Preference Share Capital Redemption of Debentures Repayment of Long term Loans Premium on redemption of preference shares/debentures Purchase of Investments/Fixed Assets Dividend Paid Taxes Paid Drawings by proprietor/partner Flow of Funds? NO Current Assets YES Current Liabilities YES YES YES Non current Assets YES Non Current NO Liabilities STEPS FOR PREPARATION OF FUND FLOW STATEMENT STEP FOR PREPARATION OF FUND FLOW STATEMENT 2

3 FIRST STEP To prepare statement of Changes in Working Capital It is very necessary to make statement of changes of working capital. Because net increase in working capital is use of fund and net decrease in working capital is source of fund. We take two balance sheets, one is current year balance sheet and other is previous year balance sheet. Then we separate current assets and current liabilities. If current assets are more than previous year current assets, it means increase in working capital. If current assets are less than previous year current assets, it means decrease in working capital. Because relationship between current assets and working capital is positive and if any changes in current assets, working capital will change in same direction. If current liabilities are more than previous year current liabilities, it means decrease in working capital. If current liabilities are less than previous year current liabilities, it means increase in working capital. Relationship between working capital and current liabilities are inverse. We can summarise the above as under: Working Capital increase/decrease when Increase working capital Decrease in working capital No change in working capital Change in current assets or current liabilities Increase in current assets Decrease in current liabilities Decrease in current assets Increase in current liabilities Realisation from debtors/bills Receivable Payment to creditors/bills Payable Goods sold on credit Goods purchased on credit Net working capital increase or decrease when a transaction involves a current account and noncurrent account. Statement or schedule of changes in working capital Particulars (a) CURRENT ASSETS Cash in hand Debtor Inventory Bills Receivable Total Current Assets (A) (b) CURRENT LIABILITIES Trade Creditors Bills Payable (c) Total Current Liabilities (B) Total Working Capital (A-B) (d) Change in Working Capital Previous Year () Current Year Effect on working capital Increase Decrease SECOND STEP 3

4 Ascertain the funds from operation Funds from the operation may be ascertained from following two methods as under: (i) In statement form (ii) In account form Fund from operation is required for preparation of fund flow statement for source of fund side. It can be shown on application of fund side when there is negative fund from operation. Operation means business activity and fund from operation means profit from business activity. Statement of fund from operations The fund flow statement is prepared as per the following Performa: Statement of Funds from operations for the Particulars Net Profit after tax for the year X Add: Non-Current/Non-Operating Expenses (E.g.) Depreciation Loss on Sale of Fixed Assets Interest on Debentures Goodwill Written Off Provision for Tax Proposed Dividend Interim Dividend Transfer from Statement of Profit & Loss (Profit & Loss Account) Other Non-Current & Non-Operating items debited X Less: Non-Current &Non Operating Incomes (e.g.) Interest on Investment Dividend Received Profit on Sale of Fixed Assets Interest on Bank Deposit Refund of Tax Other Non-Current & Non-Operating items credited X Net Fund Flow From Operation X. Fund Flow Statement in Account Form Adjusted Profit & Loss Account for the period Particulars Amount Particulars Amount To Non-Current & Non-Operating Items Charged: Transfer to General Reserve By Balance b/d By Non-Current &Non Operating Items credited Profit on Sale of Fixed Assets Goodwill Written Off Income from Investment Preliminary Expenses Other Non-Current &Non. Operating Items Depreciation By Net Fund Flow from Operation (Balancing Figure) Provision for Taxation Other Non-Current & Non Operating Items To Balance c/d 4

5 Qus 1. From the following details prepare a statement showing changes in working capital during 2012: Balance sheet of Surya as on 31 st December Liabilities Assets Share capital 5,00,000 6,00,000 Fixed assets 10,00,000 11,20,000 Reserves 1,50,000 1,80,000 Less: Depreciation 3,70,000 4,60,000 Profit and Loss A/c 40,000 65,000 6,30,000 6,60,000 Debentures 3,00,000 2,50,000 Stock 2,40,000 3,70,000 Creditors for goods 1,70,000 1,60,000 Book Debts 2,50,000 2,30,000 Provision for tax 60,000 80,000 Cash in hand 80,000 60,000 Preliminary expenses 20,000 15,000 12,20,000 13,35,000 12,20,000 13,35,000 Solution The first step is to prepare the schedule of changes in working capital. Schedule of changes in working capital Increase in Decrease in working working capital capital Current Asset: Stock 2,40,000 3,70,000 1,30,000 Book debts 2,50,000 2,30,000-20,000 Cash in hand 80,000 60,000-20,000 (A) 5,70,000 6,60,000 1,30,000 40,000 Current Liability: Creditors for goods (B) 1,70,000 1,60,000 10,,000 Working capital (A- B) 4,00,000 5,00,000 1,40,000 40,000 Increase in working capital 1,00, ,00,000 5,00,000 5,00,000 1,40,000 1,40,000 Qus 2. From the following two balance sheet of M/s Ram Traders as at December 31, 2011 and Prepare the statement of sources and uses of funds Liabilities Share capital 80,000 90,000 Trade creditors 20,000 46,000 Profit & Loss a/c 4,60,000 5,00,000 Assets Cash 60,000 94,000 Debtors 2,40,000 2,30,000 Stock in trade 1,60,000 1,80,000 Land 1,00,000 1,32,000 5,60,000 6,36,000 5,60,000 6,36,000 5

6 Solution: The first step is to prepare the schedule of changes in working capital. Schedule of changes in working capital Increase in Decrease in working working capital capital Current Asset: Cash 60,000 94,000 34, Debtors 2,40,000 2,30, ,000 Stock in trade 1,60,000 1,80,000 20, (A) 4,60,000 5,04, Current Liability: Trade creditors (B) 20,000 46, ,000 Working capital (A - B) 4,40,000 4,58,000 54,000 36,000 Increase in working capital 18, ,000 4,58,000 4,58,000 54,000 54,000 The next step is to prepare the non current accounts of the firm. Land ACCOUNT To Balance b/d 1,00,000 By Balance c/d 1,32,000 To Cash(Purchase) balancing figure 32,000 1,32,000 1,32,000 Share capital Account To Balance c/d 90,000 By Cash (Issue of shares) 10,000 Balancing figure By Balance b/d 80,000 90,000 90,000 Adjusted Profit & Loss Account To Balance c/d 500,000 ByBalance b/d 4,60,000 Funds from operation By Funds From Operation (Bal fig) 40, , ,000 Fund flow statement Sources Application Issue of Shares 10,000 Purchase of Land 32,000 Funds from operation 40,000 Increase in working capital 18,000 50,000 50,000 Qus 3. From the following balance sheets of A on 31st December 2011 and 2012, you are required to prepare Fund flow statement. The followings are additional information has also been given: 6

7 Depreciation charged on plant was 4,000 and on building 4,000 Provision for taxation of.19,000 was made during the year 2012 Interim Dividend of 8,000 was paid during the year 2012 Balance sheet Liabilities Assets Share capital 1,00,000 1,00,000 Goodwill 12,000 12,000 General Reserve 14,000 18,000 Building 40,000 36,000 Profit & Loss A/c 16,000 13,000 Plant 37,000 36,000 Sundry creditors 8,000 5,400 Investments 10,000 11,000 Bills payable 1, Stock 30,000 23,400 Provision for taxation 16,000 18,000 Bills receivable 2,000 3,200 Provision for doubtful debts Debtors 18,000 19,000 Cash 6,600 15,200 1,55,600 1,55,800 1,55,600 1,55,800 Solution: Statement of changes in working capital Increase in Decrease in working working capital capital Current Asset: Stock 30,000 23, ,600 Bills receivable 2,000 3,200 1, Debtors 18,000 19,000 1, Cash 6,600 15,200 8,600 (A) 56,600 60,800 Current liability Sundry creditors 8,000 5,400 2,600 Bills payable 1, Provision for doubtful debts (B) 9,600 6,800 Working capital (A- B) 47,000 54,000 13,800 6,800 Increase in working capital 7,000 7,000 54,000 54,000 13,800 13,800 Building Account To Balance b/d 40,000 By(Depreciation) Adjusted Profit & Loss A/c 4,000 By Balance c/d 36,000 40,000 40,000 Plant Account To Balance b/d 37,000 By(Depreciation) Adjusted To Cash (Purchase) Profit & Loss A/c 4,000 balancing figure 3,000 By Balance c/d 36,000 7

8 40,000 40,000 Investments Account To Balance b/d 10,000 By Balance c/d 11,000 To Cash (Purchase) Balancing figure 1,000 11,000 11,000 General Reserve Account To Balance b/d 18,000 By Balance b/d 14,000 By Adjusted Profit and Loss A/c 4,000 (Profit transferred during the current year) 18,000 18,000 Provision for Taxation Account To Cash (Tax paid previous year taxation) By Balance b/d 16,000 Balancing figure 17,000 By Adjusted Profit & Loss A/c 19,000 To Balance bid 18,000 (provision for taxation made during the year) 35,000 35,000 Adjusted Profit & Loss Account To Depreciation on Building 4,000 By Balance bid 16,000 To Depreciation on Plant 4,000 By Funds from operations 36,000 To Transfer to General Reserve 4,000 To Provision for taxation 19,000 To Interim dividend 8,000 T a Balance c/d 13,000 52,000 52,000 The next step is to prepare the fund flow statement. Fund Flow Statement Sources Applications Funds from operations 36,000 Purchase of the plant 3,000 Purchase of the Investment 1,000 Increase working capital 7,000 Tax paid 17,000 Interim dividend 8,000 36,000 36,000 8

9 MULTIPLE CHOICE QUESTIONS 1. also referred to as statement of source application of funds presents the movement of funds and helps to understand the changes in the structure of assets, liabilities and equity capital. a) Ratio Analysis b)cash Flow Statement c) Fund Flow Statement 2. Funds means a) Current Assets b) Working capital c) Current Liabilities d) All of the above 3. Fund from operation means a) Business Activity b) Profit from Business activity c) Both (a) and (b) 4. Funds = working capital a) Current Assets Current Liabilities b) Current Assets + Current Liabilities c) Current Assets Current Liabilities d) Current Assets Current Liabilities 5. Flow of funds include c) Both (a) and (b) 6. The term Flow of funds means Transfer of economic value from one assets to another and one liability to another. a) True b) False c) Partly True d) Partly False 7. Flow of fund a) Fixed assets changes into current asset or currents assets changes into assets b) Fixed liability changes into current liability or current liability changes into fixed liability c) Any transactions which attract one current account and one non current account then it is only flow of fund. d) (a) or (b) or (c) 8. Out of the following, example of inflow of funds are - i) Issue of Equity Share Capital ii) Issue of Preference Share Capital iii) Issue of Debentures/Long Term Loans iv) Premium on Issue of Share/ Debentures v) Redemption of Preference Share Capital vi) Redemption of Debentures vii) Repayment of long term loans viii) Premium on Redemption of Preference Shares/ Debentures a) (i), (ii), (iii), (iv) b) (ii), (iii), (iv), (v) c) (v), (vi), (vii), (viii) d) (iv), (v), (vi), (vii) 9. Out of the following, examples of outflow of funds are i) Issue of Equity Share Capital ii) Issue of Preference Share Capital iii) Issue of Debentures/Long Term Loans iv) Premium on Issue of Share/Debentures v) Redemption of Preference Share Capital vi) Redemption of Debentures vii) Repayment of Long Term Loans viii) Premium on Redemption of Preference Shares/Debentures a) (i), (ii), (iii), (iv) b) (ii), (iii), (iv), (v) c) (v), (vi), (vii), (viii) d) (iv), (v), (vi), (vii) 10. Fund flow statement is a statement showing sources and uses of funds for a period of time a) True b) False c) Partly True d) Partly False 11. A statement of sources and application of funds is a technical device designed to analysis the changes in the financial condition of a business enterprises between two dates. The definition is given by a) Foulke b) Anthony c) P.F. Drucker d) Henri Fayol 12. The funds flow statement describes the sources from which additional funds were derived and the use to which these sources were put. The definition is given by a) Foulke b) Anthony c) P.F. Drucker d) Henri Fayol 13. The features of fund flow statement is a) Shows sources of funds during a specified period b) Shows uses of funds during a specified period 9

10 c) Funds used here means working capital i.e., the excess of current assets over current liabilities d) All of the above 14. Funds flows statement are also known as i) Sources and application of funds ii) Statement of changes in financial position iii) Sources and uses of funds iv) Summary of financial operations v) Where got, where gone statement a) (i), (ii), (iii), (iv) b) (ii), (iii), (iv), (v) c) (i), (ii), (iv), (v) d) All of the above 15. in this book Management Accounting Text and Cases has explained the funds flow by way of where got, where gone statement. a) Foulke b) Prof. Anthony c) P. F. Drucker d) Henri Fayol 16. If current assets are more than previous year current asset, it means in working capital. a) Increase b) Decrease c) Both (a) and (b) 17. If current assets are previous year current assets, it means decrease in working capital. a) More than b) Less than c) Equal to d) Not equal to 18. If current liabilities are previous current liabilities, it means decrease in working capital. a) More than b) Less than c) Equal to d) Not equal to 19. If current liabilities are previous year current liabilities, it means increase in working capital. a) More than b) Less than b) Equal to d) Not equal to 20. Relationship between working capital and current liabilities are inverse. a) True b) False b) Partly True d) Partly False 21. Fund from operation is required for preparation of cash flow statement for source of fund side. a) True b) False b) Partly True d) Partly False 22. Operation means a) Business activity b) Profit from business activity c) Both (a) and (b) 23. If the amount of reserves and surplus of a company increases by 50 lakhs and the fixed assets increase by 10 lakhs over a period of time, then how much amount of funds is available for other uses? a) 50 lakhs b) 10 lakhs c) 40 lakhs d) 30 lakhs 24. If the accrued interest expense increases by 40 lakhs and the provision for taxes reduces by 50 lakhs over a period of time, then what is the amount of the excess funds used? a) 50 lakhs b) 10 lakhs c) 40 lakhs d) 30 lakhs 25. Balance Sheet of M/s A & B Liabilities Assets Capital Loan from Bank Mrs. A s Loan Current Liabilities 1,48,000 30, ,000 1,49,000 25,000 20,000 41,000 Machinery Buildings Land Stock Debtors Cash 80,000 50,000 20,000 25,000 35,000 4,000 86,000 55,000 30,000 22,000 38,400 3,600 During the year, the partners withdrew 26,000 for domestic expenditure. The provision for depreciation against Machinery as on was 27,000 and on was 36,000. Calculate the amount of change in working capital. a) 28,000 b) 23,000 c) 5,000 increase d) 5,000 decrease 10

11 26. One of the following is not an objective of funds flow analysis: a) Working capital utilization b) Statutory Requirements c) In raising new funds d) As an instrument of planning and control 27. The relationship between sources and application of funds and its impact on is explained in statement of sources and application of funds. a) working Capital b) Cash Flow c) Profit and Loss 28. The funds flow statement is prepared in between balance sheet dates. a) One b) Two c) Three 29. Any transaction which amount of working capital, is a source of working capital. a) Increase b) Decrease c) Either of the above 30. Any transaction which amount of working capital, is a application or use of working capital. a) Increase b) Decrease c) Either of the above 31. Purchase of stock-in-trade on credit will result in of funds. 32. Purchase of a fixed asset on a credit of two months. 33. Purchase of a fixed asset on long term deferred payment basis will result in of funds. 34 Sale of stock in trade at profit for cash will result in of funds. 35. Sale of fixed assets (book value J 7,000) at a loss of J 6,000 will result in of funds. 36. Cash collected from debtors will result in of funds. 37. Cash paid to creditors will result in of funds. 38. Bill receivables endorsed to creditors will result in of funds. 39. Bills receivables endorsed to creditors, dishnoured will result in of funds. 40. Issue of shares against a purchase of fixed assets. ANSWERS 1. c 2. b 3. b 4. a 5. c 6. a 7. d 8. a 9. c 10. a 11. a 12. b 13. d 14. d 15. b 16. a 17. b 18. a 19. b 20. a 21. b 22. a 23. c 24. b 25. d 26. b 27. a 28. b 29. a 30. b 31. c 32. b 33. c 34. a 35. a 36. c 37. c 38. c 39. c 40. c 11

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Financial Statements of Companies

2 Financial Statements of Companies BASIC CONCEPTS UNIT 1: PREPARATION OF FINANCIAL STATEMENTS While preparing the final accounts of a company the following should be kept in mind: Requirements of Schedule