“The funds flow statement describes the sources from which additional funds were derived and the uses to which these funds were put.”
Roy A. Fouke defines fund flow statement as “fa statement of sources and application of funds is a technical device designed to analyse the changes in the financial condition of a business enterprise between two dates.”
Thus, the fund flow statement reveals the volume of financial transactions and explains the flow of funds taking place within a business during a particular period of time and its effect on the net working capital. It is not a substitute for either the Profit and Loss Account or the Balance Sheet, but it is an useful supplement to them.
It describes the sources from which funds are obtained and the uses of these funds, in a condensed form.
An important contribution of funds flow statement is to know how funds have moved between long- term and short-term needs of the organisation. It 1s generally believed that organisation needs to match assets and liabilities on time scale though assets are always equal to hrabilities. For instance, if a firm raises funds through 364 days commercial paper and uses the money to buy a plant. There is a asset-liability mismatch between the sources and uses of funds. Suppose, the interest rate is 10% and expected return from the project is 12%. Today, the project looks profitable. But what will happen when the interest rate increases to 13% from 10% at the end one year. If the commercial paper is renewed or new commercial paper is substituted for the same, the project profitability turns negative. Further, what is the assurance that the company would be in a position to roll-over the commercial paper or substitute a new paper. If there is delay or difficulty in doing it, it will put lot of pressure on the part of organisation. Thus, prudential norms require use of long-term funds for long-term purpose and short-term funds for short-term needs, which is mainly working capital. Since it is difficult to exactly match this way, normally, if the flow is from long-term sources to short-term uses, then it is considered to be a good funds management. Here again, too much of excessive use of long-term funds for short-terms is not good. Funds flow statement shows how efficient the firm is in managing two sources of funds.
Funds flow statement is also useful to ascertain whether the firm is liquid or not and whether the firm is in a position to raise funds from operation to sustain its activities. If the firm has set some budgets, which show the funding pattern of future expansion, funds flow statement will be useful to compare whether we are able to achieve the budget terms. If the funds flow statement is prepared for the future years, then it is possible for the management to plan in advance how to manage the funds and what steps need to be taken today to raise different sources of funds.
An analysis of working capital statements will be useful to know where the need for working capital arises. Other things being equal, it 1s desirable to reduce the working capital since investments in working capital yield very low return or zero return. It is also possible to compare this statement with budgets to control the growth of working capital. Let us consider the Funds Flow Statement of BHEL to understand this point.
BHEL working capital is showing steady increase over the years. However, in all the five years, BHEL was able to generate adequate long-term funds to meet the increasing short-term needs.
Let us consider one more large Indian company to understand the issue. Sterlite Industries funds flow statement given below shows wide variation in the flow of funds. Of the five years, funds from long- term sources turned negative and it means, short-term sources are used to fund the long-term needs. As we know, Sterlite made a number of acquisition and in that process, there are some deviations in resources planning. As you see, the company 1s setting right the situation in 2001. by bringing down the gap and hopefully, it will come to normal in year 2002.
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