A comprehensive guide to Fund Flow Statement

In the financial and accounting world, one has to understand fund flow for decision-
making purposes. Fund flow statement gives a person clear visibility into exactly that.
The statement is of great help when it comes to analyzing the financial health of a
company and at the same time serves as an excellent tool for investors, managers, and
other stakeholders. The fund flow statement explains in detail how it is prepared and
the significance of the same. Subsequently, it will focus on the differences between a
Fund Flow Statement and a Balance Sheet, the relevance of the cost of capital, and
answer some of the most common questions asked about the financial tool.

The Origin of the Fund Flow Statement

In the hustle of Mumbai, in the hub of India's Financial District, beats a company called
Shakti Manufacturing Ltd. Shakti, like most people yet standing in the indigenous sector
of the economy; in the preceding decade, a change of scene would have ample markings.
Launched from a tiny workshop manufacturing textile machinery, it had really passed
into a multi-crore business whose clients were spread all over the country.

But complexity grew Pari Passu with growth. The managing director of the company, Mr.
Arvind Rao, was hard-pressed to find out increasingly, from which avenue his company's
funds were generated and where these were spent. The profit appeared up to mark on
paper, but the company experienced cash paucity often. It was akin to possessing a large
ship that was impressive from the outside but had no idea of navigation.

One good day, when he was sitting with his financial advisor, Mr. Rao, he heard the term
Fund Flow Statement. The senior described the statement this way: "Imagine this
statement to know how and what these different streams of money entering and being
spent in your business are. It not only tells you how much money you have but from
where money is coming in and where it is going."

In his captivating search for comprehensive answers, Mr. Rao got intrigued to learn
about the concept of fund flow statements.

Preparing the Map: How the Fund Flow Statement was drawn
With his advisor's guidance, Mr. Rao began the process of preparing Shakti
Manufacturing Ltd.'s first Fund Flow Statement. This is how they went about it:

1. Tracing the Changes in Working Capital

First was understanding the change in the company's working capital. How he, the
advisor explained, working capital is just like the engine of a ship that will drive daily
operations. The difference between current assets—things like cash, inventory, and
receivables—and current liabilities like payables and short-term loans ends up being
what one knows as working capital.

The advisor demonstrated that this cost, in Shakti Manufacturing, has had an increase in
receivables due to customers taking a little longer to pay. It interprets that despite the
increased sales, the company lacks ready cash at hand—like having fuel within the
reserve but not in the engine.

2. Identify the Non-Current Accounts

They then considered the non-current assets and liabilities of the company. The fixed
assets were the machinery, and the long-term loans were also against these. The advisor
said that Shakti had recently acquired new machinery valued at ₹50 lakhs for which she
had availed a loan of ₹30 lakhs to pay for it. These were big movements of funds that
should be accounted for.

3. Provisions for Profit and Loss Account

He then explained the need to adjust the profit and loss account for non-operating
items. For example, Shakti had earned a profit of ₹10 lakhs, which included a one-time
gain from selling old machinery. This needed to be adjusted to get a clearer picture of
funds generated from operations.

4. Classification of Sources and Uses of Funds

They labelled all the transactions as those that generated funds or used funds. From the
standpoint of Shakti, the fresh issue of shares to raise ₹20 lakhs was a source of funds,
and the purchase of raw materials worth ₹40 lakhs was a major use of funds.

At the end of this exercise, they had a clear picture—a Fund Flow Statement which
showed exactly how Shakti Manufacturing's funds had moved during the financial year.

A Day in the Life of a Fund Flow Statement: An Indian

Example
Let us take an example in some other industry to explain it still better. Take the case of
Shree Ganesha Sweets, one of the most popular sweet shops in Chennai, known for its
mouthwatering Mysore Pak and other traditional Indian sweets.
The Case:

The festival season is approaching, and Shree Ganesha Sweets expects demand to rise
manifold. Feeling the same, the owner, Mr. Subramanian, decides to enhance his
production capacity by purchasing new equipment worth ₹10 lakhs. For this, he avails
of a ₹5 lakh loan from the bank and ₹5 lakhs from business savings.

Later, when the sales pick up, he decides to issue shares to raise a further ₹3 lakhs for
further expansion. His loan, ₹2 lakhs, is paid off at the same time.

Particulars Amount (₹)

Sources of Funds:
Bank Loan 3,00,000
Shares Issues 3,00,000
Total Source of Funds 6,00,000
Uses of Funds:
Property, Plant & Equipment purchased 4,00,000
Loan Repaid 2,00,000
Total use of Funds 6,00,000

In the presented case, Mr. Subramanian can visualize what sources and uses of funds
were made by his business in the festive season. The Fund Flow Statement would clarify
that although he has mobilized ₹6 lakhs, he also deployed an equivalent sum without
compromising the financial standing of his business.

Balancing the Scales: Fund Flow Statement vs. Balance Sheet

Mr. Rao of Shakti Manufacturing was going through the Fund Flow Statement. He kept
on comparing it to the Balance Sheet of the company. The adviser clarified that though
both are important, they accomplish quite different tasks—as different instruments do
on the control panel of a ship.

1. Purpose:

Fund Flow Statement is, therefore, a ledger of funds over a period. It marks what its
sources are and where it is applied, thus helping in understanding the dynamics of
financial flows in the company.

In contrast, a Balance Sheet is like an instantaneous photograph at any given point in

time. It presents the financial position of the company on a given date by describing
assets, liabilities, and equity.

2. Time period:
Fund Flow Statement denotes a specific period usually consisting of one financial year
that shows change during such a period.

The Balance Sheet is a static document, capturing the financial standing of the company
on the last day of the financial year.

3. Focus:

The Fund Flow Statement has focused upon the flow of funds—how they were
generated and where they were applied.

Balance Sheet has focused on the overall financial structure of the company and shows
what the company owns and owes.

4. Constituents:

Fund Flow Statement consists of items that affect working capital as also non-current
assets and liabilities.

On the Balance Sheet, all assets and liabilities will be represented, categorized into
current and non-current.

The Pros and Cons: Advantages and Disadvantages of a Fund

Flow Statement
Like any other tool, the Fund Flow Statement has its advantages and drawbacks. Mr. Rao
identified that it was crucial to know all of it to determine how this tool could be
employed properly.

Advantages:

 Clarity on Financial Movements:

The fund flow statement was therefore very explicit to Mr. Rao on the movement of the
funds in and out of the business. As if a guide map of the financial river that contained
all the curves and the bends.

 Better Financial Planning:

Now that he knows where the funds are being generated and spent, it is easier for Mr.
Rao to plan for future expenditure and investment. They assisted him in avoiding
excessive and sudden cash problems which use to rear their head from time to time at
Shakti Manufacturing.

 Identifying Strengths and Weaknesses:

It also highlighted the specific areas of strength or weakness of the company as far as
fund management was concerned and, in this way, helped Mr. Rao to decide on which
areas were most suitable for cutting expenses or to spend more.
  Assisting in Investment Decisions:

Any investor who was always keen on viewing the Shakti’s Fund Flow Statement would
have known how the company was is a position to manage its resources and would have
had a vantage point of determining on whether or not to invest on the company.

Disadvantages:

 Historical Data

The Fund Flow Statement is made on the basis of historical information. While being
very effective to teach and explain the past movements, it is totally ineffective to forecast
the future performance of the business or the enterprise. It is like using extremely
outdated navigation to determine further direction and what is more – it costs money.

 Complexity in Preparation

Solely to prepare this statement, it required an extraordinary level of understanding and

sufficient knowledge of accounting standards. This is something that a small business
which does not even have a capable finance team could find difficult.

 Cash Flow is not reflected

This statement does not provide any information concerning the actual cash flow of the
company, how liquid the business is. Realizing that he still required other tools to get a
holistic view of the company’s financial vigor, Mr. Rao proceeded to a new set of
financial ratios.

Importance of Fund Flow Statement to Indian Businesses:

As Mr. Rao managed the small details of business finance at Shakti Manufacturing Ltd.,
he found the Fund Flow Statement very handy. Now, read the following for a better
understanding of how it listed a significant difference in the company's financial
management:

1. Clarity on Financial Movements

First and foremost, Mr. Rao was confounded by the fact that Shakti Manufacturing Ltd.
was headed into cash flow problems despite healthy profits on the table. The Fund Flow
Statement was the go-to tool that really helped Mr. Rao unlock this mystery of sorts. It
clearly outlined where the funds come from—operations, financing, and investments—
and where these funds go. In breaking down these movements, Mr. Rao would see that
while the company was profitable on paper, a large proportion of funds was tied up in
inventory and receivables. This sharpness proved very important with the cash flow
problem, and liquidity many times was provided on an ad hoc basis.
2. Better Financial Planning

Every business needs the most optimal financial planning, and the Fund Flow Statement
provided Mr. Rao with a vantage point to look into the future. A review of the inflow and
outflow of funds enabled him to forecast with reasonable accuracy where the firm
would head in terms of future finance requirements. Be it the preparation of a major
capital expenditure, planning for debt repayment, or keeping aside the funds for
unforeseen expenses, Fund Flow Statement gave Mr. Rao the insights he needed to plan
effectively. This proactive approach ensured that Shakti Manufacturing Ltd. is always
prepared to meet its financial obligations and seize investment opportunities.

3. Areas of Strength and Weakness Identification

The Fund Flow Statement not only indicated where the funds were flowing, but also
brought out the inefficiencies in the operation of the company. For example, Shakti
Manufacturing Ltd. had considerably long delays in receivables. Armed with this
observation, Mr. Rao could institute tighter control of credit to customers, thereby
improving cash flow and reducing the level of bad debts. Further, it was able to locate
the points in which the company was highly financially intensive, and such information
Mr. Rao could use in strategic decision making.

4. Informed Decision Making

Mr. Rao could make quick and informed decisions using the right data regarding where
to invest, how to manage debt, and deploy resources. The Fund Flow Statement was
very helpful in forming a clear picture of the health of the company, helping him to
compare the potential impacts of every decision he made on the cash flow of the
company. Deciding between an investment in new machinery or additional debt also
used to be led by the said statement, for it would be one sure guide that each decision
was thoroughly supported by valid financial records.

5. Building Investor Confidence

Mr. Rao found the Fund Flow Statement extremely effective in exhibiting transparency in
using finance; and used to share this statement with investors on a regular basis to be in
a position to show those right at that time what the funds are actually used for. Such
transparency gained their trust in the company and attracted more investment, since
the investors were assured that the company was being managed efficiently and in a
responsible manner".
6. Planning Strategic growth

During Shakti Manufacturing Ltd. the expansion quest, the Fund Flow Statement helped
in detecting the implication of such growth venture. With the analysis, Mr. Rao was
capable of predicting what Shakti Manufacturing Ltd. would be able to continue such
expansion and then by the end of the said time if it would be a workable and
maintainable business. This careful planning ensured that the expansion plans were
well thought out and were in keeping with the company's financial resources and did
not result in overstretching its resources.

7. Crisis Management

Fund Flow Statement was of great help during the period of a financial crisis. In a
situation of falling sales or rising operating costs, Mr. Rao was able to pinpoint the
problem areas in a flash from this statement. This meant he could very soon pick up the
problems and give sharp remedial measures whether to cut or source other funds for
down unessential expenditures. The ability of the statement was such that, even during
financially hard times, it kept the company floating, therefore making Shakti
Manufacturing Ltd. always be firm in its stability.

8. Improving Operational Efficiency

Operational efficiency ensures continued profitability, and the Fund Flow Statement
helped Mr. Rao control cost leakage points. For instance, the statement revealed that the
company was facing high maintenance costs because of many obsolete machines.
Consequently, Mr. Rao chose to shed the cost and buy new, more efficient equipment.
This not only resulted in reducing operating costs but also boosted production
efficiencies. This strategy toward bettering the cost structure was required to maximize
the profit contribution to the company.

9. Alignment of Financial Goals with Strategy

In any business enterprise, clear financial goals for the long term cannot be separated
from the strategy of doing business. Fund flow statement enabled Mr. Rao to achieve this
end by providing him with an accurate reflection of the financial position of the
company. With this information, he would ensure that every strategic move, whether it
was entering a new market or launching a new product, had the necessary financial
resources behind it. Such alignment between financial goals and business strategy
empowered Mr. Rao to make decisions that propelled the company forward.

10. Compliance and Accountability

In a scenario where day by day, regulatory compliance is coming to the fore, the Fund
Flow Statement was an open record of using the funds. Such transparency helped Shakti
Manufacturing Ltd. remain close to the regulatory requirements but kept financial
accountability intact. Regular reviews by Mr. Rao ensured that the company adhered to
financial best practices, hence reducing the risk of legal issues and penalties.

Conclusion
The Fund Flow Statement, in simple words, is one financial tool that transcends the
conventional systems of accounting in its capacity to give much more profound insights
into the financial health of a company. For businesses like Shakti Manufacturing Ltd., it
gives clarity on the movement of funds, helps in strategic planning, and refines decision-
making. It helps them align their financial goals with the business strategy through
orientation towards operational efficiency and building investor confidence. Even
though it is not without its limitations, the Fund Flow Statement has always been a very
important tool to find one's way through the maze of business finance in the
contemporary world, making good provisions for stability, compliance, and growth in a
sea of constant evolution.

FAQs

1. What do you mean by a Fund Flow Statement?

A statement that shows how the inflows and outflows of funds in a business during any
period. A Fund Flow Statement also shows sources from which funds have been
obtained and the applications to which they have been put in summarized form.

2. How are Fund Flow Statements and Cash Flow Statements different?

As both statements trace the flow of financial resources, there is a difference which is
the Fund Flow Statement focuses on changes in working capital, whereas the Cash Flow
Statement deals pretty much exclusively with cash transactions.

3. Do Indian businesses find the Fund Flow Statement important?

It reflects the financial health of the Indian business, and it also shows a way forward to
plan the future needs of the business, and it pinpoints inefficiencies so that correct and
informed decisions about future investments or use of any resource can be made.
4. Are there any essential elements of the Fund Flow Statement?

The essential elements to the Fund Flow Statement are changes in working capital,
sources of funds, and application or uses of funds—events such as loans, equity,
purchasing of assets, and repayment of debt.

5. Is there a specific way to prepare the Fund Flow Statement?

It can prepared by analyzing any changes in the balance sheet of the company for n
number of periods and by finding out sources and dedicated uses of funds and
classifying them to reflect the changes in working capital.

6. Can the Fund Flow statement help in managing liquidity of a business?

Yes, a fund flow statement can help so because it provides insights into the movement of
funds that a business can do, hence manages its liquidity in a manner that makes sure it
has sufficient resources to meet all its short-term obligations.

7. Are there any limitations to a Fund Flow Statement?

It is prepared based on historical data. Also, it does not reflect cash flow directly and its
preparation is complex and requires a sound knowledge of accountancy.

8. Who are the users of the Fund Flow Statement?

The Fund Flow Statement is primarily used by the management of the company,
investors, financial analysts and auditors to analyze the financial health of the company
and to arrive at correct decisions.

9. What is the frequency by which the Fund Flow Statement should be prepared?

Generally, a Fund Flow Statement is prepared on an annual or a semi-annual basis, but

with the need, any business could prepare it frequently to help with internal analysis or
financial planning.

10. Can Fund Flow Statement be used for forecasting?

Primarily being a tool for the history and insights learned from the Fund Flow Statement
help in projecting future financial needs and deciding upon their meeting.