CAIIB 2024 JUNE MATERIAL | DEFINITION OF FUND FLOW STATEMENT

CAIIB 2024 JUNE MATERIAL | DEFINITION OF FUND FLOW STATEMENT

This article talks about the fund flow statement, in how you can analyze these statements & can get the maximum benefit for trading & decision-making purposes. So, read the article as it is an important topic from the prescribed syllabus of the ABM CAIIB 2024 Exam whether you are preparing for the June 2024 Exams or the upcoming December attempt.

FUND FLOW STATEMENT 

It is a statement prepared with the aim to analyse the reasons for fluctuations or changes in the company’s financial position between two balance sheet dates. It presents the inflow & outflow of funds i.e. from where the funds are sourced and where the funds are applied for a particular period.

It can also be said that a fund flow statement is prepared so that any changes in the working capital position of a company can be explained.

PURPOSES OF FUND FLOW STATEMENT

There might be times when you would have questioned yourself as to why you prepare a fund flow Statement when you already have access to the profit and loss & balance sheet. But if you would have ever analyzed the profit and loss statements and balance sheet then you would have analyzed that these do not provide or explain the reasons for a change or fluctuation in the financial position.

Profit and loss statement & balance sheet usually have 2 years figures i.e., current year & previous years’. And it usually does not explain the reasons for changes. Such as to what extent the long-term funds are used for long-term requirements and to what extent the short-term funds are used for long-term and short-term requirements. 

Following are the reasons for why fund flow statements are prepared. It provides us two types of information: 

• Sources of funds – The source of money from where it comes in
• Application of funds – The purposes for which the money is being used.

COMPONENTS OF A FUND FLOW STATEMENT

Statement of fund flow consists of two basic elements: 

Sources of funds: It contains a list of sources and the extent of the funds which are availed from those listed sources such as: 

• Funds from owners 
• Funds from outsiders 

Application of funds: It contains the list of items or places where the funds are deployed. For example: 

• Fixed assets 
• Current assets

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EXPLANATION OF FUND FLOW STATEMENT WITH EXAMPLES

Suppose, ‘NVM Enterprises’ raises its funds from: Long term funds for its non-current assets.

Explanation: Non-current assets in the company’s long-term investments, these assets do not realize their value in one accounting year. Example: Plant and equipment, intellectual property, investments, and land, etc.

In accounting, it is generally considered a good practice to use the funds raised from long-term sources for long-term purposes or requirements. So, NVM Enterprises using the long-term funds for non-current assets is the right practice and this fact can easily be identified by analyzing the fund flow statement.

What if NVM Enterprises uses its short-term funds to finance its long-term assets?

Now the question is, what if NVM enterprises had been using its short term funds for its long term requirements? 

If we were to use the fund flow statement, it would have conveyed today’s uses of financial information that the funds raised by the enterprise are not being properly utilised because it is very risky to utilise the short-term funds to finance the long-term requirements of assets.

In the above situation, the company will need to repay its short-term obligations otherwise it will be in a cash crunch because it will be in no position to convert the long-term asset put cash at a later stage because of the nature of the investment.

This is how we can use the fund flow statement to analyse different situations and get explanations for the sources of funds and utilisation or application. This statement also allows the users to interpret and understand the impact of fund sources and their utilisation on the business.

ADVANTAGES OF PREPARING A FUND FLOW STATEMENT

• Preparing a fund flow statement helps in providing explanation to the managers of funds the reasons why the company is suffering from liquidity crisis despite the fact that the company is making profits which is usually reflected in the profit and loss statement.
• It also helps the managers to understand why the companies still stand financially strong in spite of the losses as shown in the profit and loss statement. 
• This provides a basis to analyse whether or not the short term funds are being used for long term purposes. This way, the fund flow statements highlight the grey areas in the company.

USERS OF FUNDS FLOW STATEMENT

The most common uses of this statement are the persons who lend money for capital purposes. 

Individuals or entities who pay more attention to fund-flow statements than the balance sheet or profit and loss. 

If we were to take an example, you can think of the banks who lend money to companies or entities in the form of overdraft or cash credit in consideration of interest. The information provided in the statement of profit and loss and balance sheet is used to prepare the fund flow statement and this statement let the banks decide as to whether they should provide the credit facilities to its clients or not.

Fund flow statement format

Fund flow statement format

Increase in working capital

If the company has more than the money in its working capital. i.e the funds are lying idle instead of getting utilised. It can work as a free flexible source which the company can utilise to fund its working capital i.e repayment of short term loans or payment of dividends.

Decrease in working capital

This situation indicates that there are far too many places where the funds needs to be employed for long term purposes but the sources of funds are limited. So in this case, the company will use lean go and make use of the funds available for working capital.

This will result in the company diverting the funds available for working capital purposes for long term use. Therefore, the funds available for working capital are decreased and instead they are utilised for long term purposes.