A Funds Flow Statement is a financial report that outlines the movement of funds within a business during a specific period. It highlights the sources from which funds were generated and the uses to which they were applied, focusing primarily on changes in working capital. Preparing this statement helps businesses understand how financial resources are managed and supports strategic financial planning.
1. Steps to Prepare a Funds Flow Statement
Preparing a Funds Flow Statement involves several systematic steps. Each step ensures that all aspects of financial movements are accurately captured and presented.
A. Step 1: Prepare a Comparative Balance Sheet
Start by preparing a Comparative Balance Sheet that shows the financial position of the company at the beginning and end of the accounting period. This will help identify changes in assets, liabilities, and equity.
- Compare the current year’s balance sheet with the previous year’s to identify increases or decreases in assets and liabilities.
B. Step 2: Determine Changes in Working Capital
Working Capital is the difference between current assets and current liabilities. Calculate the change in working capital to determine whether there has been an increase or decrease during the period.
- Increase in Current Assets: Represents a use of funds.
- Decrease in Current Assets: Represents a source of funds.
- Increase in Current Liabilities: Represents a source of funds.
- Decrease in Current Liabilities: Represents a use of funds.
Formula: Working Capital = Current Assets – Current Liabilities
C. Step 3: Identify Sources of Funds
List all sources from which funds were generated during the period. These include:
- Funds from Operations: Net profit adjusted for non-cash items like depreciation and amortization.
- Sale of Fixed Assets: Proceeds from selling property, plant, or equipment.
- Issuance of Shares or Debentures: Capital raised through equity or debt financing.
- Long-Term Borrowings: Loans or other long-term liabilities incurred.
D. Step 4: Identify Uses of Funds
List all activities where funds were used during the period. These include:
- Purchase of Fixed Assets: Investments in property, plant, and equipment.
- Repayment of Long-Term Debt: Payments made to settle long-term obligations.
- Payment of Dividends: Distribution of profits to shareholders.
- Increase in Working Capital: If current assets increase more than current liabilities.
E. Step 5: Prepare the Funds Flow Statement
Organize the identified sources and uses of funds into a structured statement. Ensure that the total sources of funds equal the total uses of funds, reflecting a balanced financial movement.
2. Format of a Funds Flow Statement
The funds flow statement typically follows a simple, clear format, making it easy to track the movement of funds.
A. Standard Format
| Sources of Funds | Amount ($) |
|---|---|
| Funds from Operations | |
| Sale of Fixed Assets | |
| Issuance of Shares/Debentures | |
| Long-Term Borrowings | |
| Total Sources of Funds |
| Uses of Funds | Amount ($) |
|---|---|
| Purchase of Fixed Assets | |
| Repayment of Long-Term Debt | |
| Payment of Dividends | |
| Increase in Working Capital | |
| Total Uses of Funds |
3. Example of Preparing a Funds Flow Statement
Let’s go through an example to understand the process of preparing a funds flow statement.
A. Scenario
XYZ Ltd provides the following data for the year ending December 31, 2023:
- Net Income: $40,000
- Depreciation: $10,000
- Sale of Equipment: $5,000
- Issuance of Shares: $20,000
- Purchase of Machinery: $15,000
- Repayment of Long-Term Debt: $10,000
- Dividends Paid: $8,000
- Increase in Working Capital: $12,000
B. Step-by-Step Preparation
1. Calculate Funds from Operations:
- Net Income: $40,000
- Add Depreciation (non-cash expense): $10,000
- Total Funds from Operations = $50,000
2. List the Sources of Funds:
- Funds from Operations: $50,000
- Sale of Equipment: $5,000
- Issuance of Shares: $20,000
- Total Sources of Funds = $75,000
3. List the Uses of Funds:
- Purchase of Machinery: $15,000
- Repayment of Long-Term Debt: $10,000
- Dividends Paid: $8,000
- Increase in Working Capital: $12,000
- Total Uses of Funds = $45,000
C. Final Funds Flow Statement for XYZ Ltd
| Sources of Funds | Amount ($) |
|---|---|
| Funds from Operations | 50,000 |
| Sale of Equipment | 5,000 |
| Issuance of Shares | 20,000 |
| Total Sources of Funds | 75,000 |
| Uses of Funds | Amount ($) |
|---|---|
| Purchase of Machinery | 15,000 |
| Repayment of Long-Term Debt | 10,000 |
| Dividends Paid | 8,000 |
| Increase in Working Capital | 12,000 |
| Total Uses of Funds | 45,000 |
4. Analysis and Interpretation
Net Funds Available: The total sources of funds ($75,000) exceed the total uses of funds ($45,000) by $30,000. This indicates that XYZ Ltd has a surplus of funds, which can be used for future investments or retained as reserves.
Key Observations:
- Strong Operational Performance: The company generated substantial funds from operations, indicating profitability and efficient cost management.
- Strategic Investments: The purchase of machinery suggests a focus on expanding operational capacity.
- Debt Management: The repayment of long-term debt indicates an effort to reduce financial liabilities and improve financial health.
- Dividend Payout: The payment of dividends reflects the company’s commitment to returning value to shareholders.
5. The Importance of Preparing a Funds Flow Statement
Preparing a Funds Flow Statement is essential for understanding how a company generates and uses its financial resources. It provides valuable insights into operational performance, investment strategies, and financial management. By tracking the sources and uses of funds, businesses can make informed decisions, plan for future growth, and ensure long-term financial stability. The statement serves as a critical tool for both internal management and external stakeholders, offering a comprehensive view of the company’s financial health.