A Funds Flow Statement is a financial document that shows the movement of funds in and out of a business over a specific period. It highlights how funds are generated and utilized, offering insight into the company’s financial health and liquidity management. The statement provides a broader view of a company’s financial activities compared to other financial documents like the income statement or balance sheet.
In this blog post, we will explore what a Funds Flow Statement is, its importance, and how it’s used in finance.
Understanding the Funds Flow Statement
The Funds Flow Statement outlines the sources of funds (where the funds came from) and the application of funds (how the funds were used). This helps financial analysts, stakeholders, and managers understand the company’s financial decisions, including whether it is borrowing to finance operations or investing in long-term assets.
Funds Flow Statements are typically divided into three parts:
- Sources of Funds: Where the company obtained funds during the period (e.g., long-term loans, equity financing, sales of assets).
- Application of Funds: How the company used its funds (e.g., capital expenditures, payment of debt, investments).
- Net Change in Working Capital: The difference between current assets and current liabilities, which reflects changes in the company’s liquidity.
Key Elements of a Funds Flow Statement
The Funds Flow Statement is composed of several important sections:
1. Sources of Funds
These represent the inflows of cash or funds into the company. Some common sources include:
- Issue of shares or bonds: Raising funds through equity or debt.
- Long-term loans: Borrowing from financial institutions.
- Sale of assets: Liquidating long-term assets like equipment or real estate.
- Operational profits: Cash generated from operating activities.
2. Uses (Applications) of Funds
These represent the outflows or uses of the funds by the company. Common applications include:
- Purchase of fixed assets: Investments in property, machinery, or equipment.
- Repayment of loans: Paying back long-term liabilities.
- Payment of dividends: Distributing profits to shareholders.
- Increase in working capital: Using funds to increase the company’s operational capital.
3. Change in Working Capital
This section examines how the company’s working capital (current assets minus current liabilities) has changed during the reporting period. It’s a key indicator of the company’s ability to meet short-term obligations. If a company has a positive change in working capital, it means it has more funds available for day-to-day operations.
Importance of a Funds Flow Statement
While the balance sheet provides a snapshot of a company’s financial position at a single point in time, and the income statement shows profitability over a period, the Funds Flow Statement focuses on how financial resources are managed over time. This makes it a crucial tool for several reasons:
1. Cash Flow Management
The Funds Flow Statement helps companies manage their cash flow more effectively by showing how and where funds are allocated. This ensures that the company can meet its financial obligations, such as paying suppliers, employees, and creditors, without facing liquidity issues.
2. Financial Planning
The statement offers insights into the company’s financial decisions, helping managers plan for the future. For instance, if a company consistently relies on debt to finance its operations, it may need to revise its financial strategy.
3. Investment Decisions
Investors use the Funds Flow Statement to assess how well the company manages its funds and whether it is generating enough internal funds to finance growth or relies heavily on external borrowing. This can influence investment decisions.
4. Identifying Trends
The Funds Flow Statement highlights trends in capital structure, such as whether the company is increasing or decreasing its reliance on debt, which is important for evaluating long-term financial sustainability.
How is the Funds Flow Statement Different from the Cash Flow Statement?
Although both the Funds Flow Statement and the Cash Flow Statement deal with the movement of money in and out of the business, they focus on different aspects:
- The Funds Flow Statement tracks changes in working capital and long-term financial movements. It shows how funds (not just cash) are generated and used, emphasizing long-term financial planning and changes in financial position.
- The Cash Flow Statement is more specific to cash transactions. It records the inflow and outflow of actual cash in operations, investing, and financing activities, giving a real-time view of liquidity.
In summary, the Funds Flow Statement provides a broader view of financial health by examining all forms of funding and their usage, not just cash.
Steps to Prepare a Funds Flow Statement
To prepare a Funds Flow Statement, follow these steps:
- Prepare the Balance Sheet: Obtain the balance sheets from the beginning and end of the period.
- Identify Changes in Working Capital: Calculate the changes in current assets and current liabilities between two periods.
- Identify Sources and Applications of Funds: Determine the sources (such as capital raised or loans taken) and applications (such as fixed asset purchases or loan repayments) of funds.
- Prepare the Statement: List the sources of funds, applications of funds, and the net change in working capital.
Conclusion
The Funds Flow Statement is an essential tool for businesses, helping them track how funds are sourced and applied within the organization. It offers a broad overview of financial health, covering long-term financial strategies and changes in working capital. For financial analysts, investors, and management, understanding this statement is key to making informed decisions about investments, cash flow management, and overall financial planning.
By keeping a close eye on the movement of funds, businesses can ensure they are using their resources efficiently, paving the way for sustainable growth and success.
