Financial Management - Fund Flow Analysis

 

FINANCIAL MANAGEMENT

Fund Flow Analysis

Part A: Discussion of basic theories including various methods and techniques of preparing the Funds Flow Statement and explanation of important definitions and points relevant to analysing the funds flow of a business enterprise effectively in order to preparing the Funds Flow Statement most appropriately.

Part B: 7 Illustrations with solutions

Part A

Definitions

Fund is the other name of working capital. We know that working capital is the excess of the value of current assets (including loans and advances) over the value of current liabilities (including provisions). Therefore, fund can also be defined as the capital which is not fixed and which is required for running the business operations on day to day basis.

 

Fund flow implies the difference between the opening balance and the closing balance of fund with respect to an accounting year. If the closing balance of fund is less than the opening balance, it can be termed as outflow of fund over the period of the accounting year. On the other hand, if the closing balance of fund is more than the opening balance, it can be termed as inflow of fund.

 

Fund flow analysis implies a systematic analysis of the fund flow to identify the reasons of increase or decrease in the balance of fund over the period of the accounting year.

 

Technique of fund flow analysis

Technique of fund flow analysis involves following three steps:

1.   Preparation of statement showing computation of funds from operations;

2.   Preparation of statement showing changes in working capital; and

3.   Preparation of funds flow statement.

 

Step: I

Preparation of statement showing computation of funds from operations

Funds from operations can be computed either in direct method or in indirect method.

Direct method:

Statement showing computation of funds from operations

	Particulars	Rs	Rs
	Sales		×××
LESS	Raw materials consumed	×××
LESS	Power and fuel	×××
LESS	Wages, salaries and bonus	×××
LESS	Workmen and staff welfare expenses	×××
LESS	Repairs and maintenance	×××
LESS	Brokerage and commission	×××
LESS	Insurance premium	×××
LESS	Rent, rates and taxes	×××
LESS	Contribution to provident fund	×××
LESS	Contribution to superannuation fund	×××
LESS	Pension and gratuity	×××
LESS	Research and development	×××
LESS	Travelling expenses	×××
LESS	Directors’ fees	×××
LESS	Audit fees	×××
LESS	Turnover tax	×××
LESS	Sales tax	×××	×××
	Funds from operations		×××

 

Note:

Items like depreciation, provision for bad and doubtful debts, losses and gains of non-trading nature, write offs, interest on debentures and loans, etc. are not to be considered while calculating the funds from operations under direct method.

 

Indirect method:

Statement showing computation of funds from operations

	Particulars	Rs	Rs
	Net profit for the year ended.........(as per the balance sheet)		×××
ADD	Transfer to General Reserve, DRR, W C Reserve	×××
ADD	Proposed dividend of current year (if appears in balance sheet)	×××
ADD	Interim dividend paid	×××
ADD	Preference dividend paid	×××
ADD	Provision for tax (provision made during the current year)	×××	×××
	Net profit before tax		×××
ADD	Depreciation on fixed assets	×××
ADD	Loss on sale of fixed assets	×××
ADD	Goodwill written off	×××
ADD	Preliminary expenses written off	×××
ADD	Interest on debentures, loans and public deposits (treated as non-operating expense)	×××
ADD	Loss on sale of long term investments	×××
ADD	Discount on issue of shares/debentures written off	×××
ADD	Premium on redemption of debentures/ preference shares	×××	×××
			×××
LESS	Profit on sale of fixed assets	×××
LESS	Profit on sale of long term investments	×××
LESS	Dividend on investments in shares	×××
LESS	Interest on investments in debentures	×××
LESS	Discount on redemption of debentures/ preference shares	×××	×××
	Funds from operations		×××

 

Step: II − Preparation of statement showing changes in working capital

Statement showing changes in working capital

Particulars	Previous Year (Rs)	Current Year(Rs)	Increase in W.C. (Rs)	Decrease in W.C. (Rs)
Current Assets:
Closing stock (net of provision)	×××	×××	×××	×××
Sundry debtors (net of provision)	×××	×××	×××	×××
Marketable securities (short-term investments)	×××	×××	×××	×××
Accrued incomes	×××	×××	×××	×××
Cash at bank / hand	×××	×××	×××	×××
Loans and advances	×××	×××	×××	×××
Bills receivable	×××	×××	×××	×××
Prepaid expenses	×××	×××	×××	×××
TOTAL (A)	×××	×××
Current Liabilities:
Sundry creditors	×××	×××	×××	×××
Bills payable	×××	×××	×××	×××
Outstanding expenses	×××	×××	×××	×××
Incomes received in advance	×××	×××	×××	×××
Bank overdraft	×××	×××	×××	×××
TOTAL (B)	×××	×××
Working Capital (A – B)	×××	×××
Increase / Decrease in W.C.	×××	×××	×××	×××
	×××	×××	×××	×××

 

Step: III − Preparation of funds flow statement

Funds flow statement for the year ended........................

Sources	Rs	Applications	Rs
Funds from operations	×××	Funds lost in operations	×××
Issue of share capital	×××	Redemption of preference shares	×××
Issue of debentures	×××	Redemption of debentures	×××
Raising other long term loans	×××	Repayment of long term loans	×××
Sale of fixed assets	×××	Buy-back of equity shares	×××
Sale of investments	×××	Purchase of fixed assets	×××
Dividend received	×××	Purchase of investments	×××
Interest received	×××	Payment of proposed dividend of previous year	×××
Decrease in working capital	×××	Payment of interim dividend
		Payment of interest (treated as non-operating expense)	×××
		Payment of tax (treated as non-current item)	×××
		Increase in working capital	×××
	×××		×××

 

Some Important Points / Explanations:

1.   Current Investments

Current investments are considered as part of working capital.

 

2.   Treatment of bank overdraft and cash credit

Bank overdraft and cash credit are to be treated as short-term borrowings and should be considered as part of current liabilities.

 

3.   Provision against current assets

Very often provision is made for doubtful debts and obsolescence or loss in the value of inventory. In such cases the concerned item of current asset should be shown net of provision in the “Statement showing changes in working capital”.

 

4.   Treatment of bad debts

Bad debts written off during the year may be added back to the closing balances of provision for doubtful debts and trade receivables. Alternatively, the adjustment of writing off of bad debts may be ignored and the solution can be given on the basis of the closing balances of provision for doubtful debts and trade receivables as appearing in the balance sheet without adding back the bad debts written off during the year to the said closing balances.

 

5.   Purchasing a business by issue of fully paid shares

If assets and liabilities of another company are purchased by issuing fully paid shares, the entire amount of issue of shares against the business purchase should be shown as source of fund and acquisition of fixed assets should be shown as application of fund. The “Statement showing changes in working capital” will be prepared as usual.

 

6.   Treatment of proposed dividend

(a)    Dividend proposed for the previous year will be an application of fund, unless otherwise stated, on the assumption that the proposed amount has been approved by the shareholders in the AGM.

(b)    No effect is given to Proposed Dividend for the current year as it is not provided for and is a contingent liability.

(c)     Any unpaid dividend is transferred to Dividend Payable A/c / Unpaid Dividend A/c which is shown in the Balance Sheet of the current year as Other Current Liabilities under Current Liabilities.

 

7.   Interest on debentures and loans

As advocated by The Institute of Chartered Accountants of India (ICAI) in AS3 – Cash Flow Statement, it has to be added back in the “Statement showing computation of funds from operations” and then payment of interest has to be shown as application of fund in the “Funds flow statement”.

 

8.   Unclaimed dividend

It is the dividend which could not be distributed by the company due to shareholders’ indifference such as non-presenting the dividend warrant to bank or change of address without intimation to the company, etc. In the balance sheet unclaimed dividend is shown under the head “Current Liabilities” so long as it is not claimed.

 

Like proposed dividend, unclaimed dividend can also be treated either as current liability or as noncurrent liability. If it is treated as current liability, it will be shown in the “Statement showing changes in working capital” like other current liabilities. In that case, no further treatment will be required for this, either in the “Statement showing computation of funds from operations”, or in the “Funds flow statement”.

 

If unclaimed dividend is treated as non-current liability, it will not be shown in the “Statement showing changes in working capital”. In this case, there may be two different situations requiring two different accounting treatments.

 

Situation: I

If the balance of unclaimed dividend at the end of the current year is more than the balance at the end of the previous year, the amount of increase will be transferred to the proposed dividend account by making the following journal entry:

Date	Particulars	L.F.	Debit  (Rs)	Credit (Rs)
	Proposed dividend A/c         Dr
	To Unclaimed dividend A/c
	(Increase in unclaimed dividend during the current year transferred to Proposed Dividend Account)

 

Under this situation, the amount of proposed dividend (of the previous year) paid during the current year will be assumed to be the amount as reduced by the amount of increase in the balance of unclaimed dividend.

 

Situation: II

If the balance of unclaimed dividend at the end of the current year is less than the balance at the end of the previous year, the amount of decrease will be assumed to be the amount of unclaimed dividend (of the previous year) paid during the current year. The necessary journal entry made for such payment of unclaimed dividend was:

Date	Particulars	L.F.	Debit  (Rs)	Credit (Rs)
	Unclaimed dividend A/c          Dr
	To Bank A/c
	(Amount of unclaimed dividend of the previous year paid during the current year)

 

9.   Goods lost in transit

It is an abnormal (i.e. non-operating) event. So it has to be added back in the “Statement showing computation of funds from operations”. Then it has to be shown as application of fund in the “Funds flow statement”.

Part B 

Illustration: 1

From the following Balance Sheets of Priceless Ltd. prepare Funds Flow Statement for the year 2016.

                                  Balance sheets as at                             (Rs in ’000)

Liabilities	31.3.15	31.3.16	Assets	31.3.15	31.3.16
Equity sh. capital	150	200	Goodwill	50	40
9% Red. Pref. sh. cap	75	50	Land & Building	100	85
Capital Reserves	-	10	Plant & Machinery	40	100
General Reserves	20	25	Investments	10	15
P/L Account	15	24	Debtors	70	85
Proposed Dividend	21	25	Stock	39	55
Creditors	13	24	Bills Receivable	10	15
Bills Payable	10	8	Cash in hand	7	5
Liability for Expenses	15	18	Cash at bank	5	4
Provision for tax	20	25	Preliminary Expenses	8	5
	339	409		339	409

 

Additional information:

1.    A part of land was sold out in 2016, and the profit was credited to Capital Reserve.

2.    A machine has been sold for Rs 5,000 (written down value of the machinery was Rs 6,000). Depreciation of Rs 5,000 was charged on plant in 2016.

3.    An interim dividend of Rs 10,000 has been paid in 2016.

4.   An Amount of Rs 1,000 has been received as dividend on investment in 2016.

 

 Solution: 1

 

Illustration: 2

The Balance Sheets of Pinnacle Corporation as at the end of 2015 and 2016 are given below:

Liabilities	2015 (Rs)	2016 (Rs)	Assets	2015 (Rs)	2016 (Rs)
Share capital	1,00,000	1,50,000	Freehold land	1,00,000	1,00,000
Share premium	-	5,000	Plant at cost	1,04,000	1,00,000
General Reserves	50,000	60,000	Furniture at cost	7,000	9,000
P/L Account	10,000	17,000	Investments	60,000	80,000
6% Debentures	70,000	50,000	Debtors	30,000	70,000
Provision for dep. (on plant)	50,000	56,000	Stock	60,000	65,000
Provision for dep. (on Furniture)	5,000	6,000	Cash	30,000	45,000
Provision for taxation	20,000	30,000
Creditors	86,000	95,000
	3,91,000	4,69,000		3,91,000	4,69,000

 

A plant purchased for Rs 4,000 (Depreciation provided Rs 2,000) was sold for Rs 800 on 30^th September, 2015. On 30^th June, 2015 an item of furniture was purchased for Rs 2,000. These were the only transactions concerning fixed assets during 2015. A dividend of 22½ % on original shares was paid. You are required to prepare funds Flow Statement and verify the results by preparing a schedule of changes in Working Capital.

 

 Solution: 2

 

Illustration: 3

From the Balance Sheet of Benevolent Ltd., please prepare:

A. A Statement of changes in the Working Capital.

B. Funds Flow Statement.

Balance Sheet at

	31st March			31st March
Liabilities	2015 (Rs)	2016 (Rs)	Assets	2015 (Rs)	2016 (Rs)
Equity share capital	3,00,000	4,00,000	Goodwill	1,15,000	90,000
8% Pref. Sh. Cap.	1,50,000	1,00,000	Land & Buildings	2,00,000	1,70,000
P/L Account	30,000	48,000	Plant	80,000	2,00,000
General reserves	40,000	70,000	Debtors	1,60,000	2,00,000
Proposed dividend	42,000	50,000	Stock	77,000	1,09,000
Creditors	55,000	83,000	Bills receivable	20,000	30,000
Bills payable	20,000	16,000	Cash in hand	15,000	10,000
Provision for taxation	40,000	50,000	Cash at bank	10,000	8,000
	6,77,000	8,17,000		6,77,000	8,17,000

 

Following is the additional information available:

i.      Depreciation of Rs 10,000 and Rs 20,000 have been charged on Plant and Land and Buildings respectively in 2016.

ii.     Interim dividend of Rs 20,000 has been paid in 2016.

iii.    Income tax of Rs 35,000 has been paid in 2016.

 

 Solution: 3

 

Illustration: 4

From the following balance sheets of Reindeers Limited prepare a statement showing the changes in the Working Capital and Funds Flow Statement during the year 2015.

Balance sheet as at

	Rs	Rs
Assets:	31.12.2014	31.12.2015
Fixed assets (net)	5,10,000	6,20,000
Investments	30,000	80,000
Current assets	2,40,000	3,75,000
Discount on debentures	10,000	5,000
Total	7,90,000	10,80,000
Liabilities:
Equity share capital	3,00,000	3,50,000
Preference share capital	2,00,000	1,00,000
Debentures	1,00,000	2,00,000
Reserves	1,10,000	2,70,000
Provision for doubtful debts	10,000	15,000
Current liabilities	70,000	1,45,000
Total	7,90,000	10,80,000

 

You are informed that during the year:

i.      A machine costing Rs 70,000 book value Rs 40,000 was disposed of for Rs 25,000.

ii.     Preference share redemption was carried out at a premium of 5%, and

iii.    Interim Dividend at 15% was paid on equity shares for the year 2014.

 

Further:

1.    The provision for depreciation stood at Rs 1,50,000 on 31^st December, 2014 and at Rs 1,90,000 on 31^st December, 2015; and

2.   Stock which was valued at Rs 90,000 as on 31^st December, 2014 was written up to its cost Rs 1,00,000 for preparing Profit and Loss account for the year 2015.

 

Solution: 4 

Illustration: 5

The directors of Chintamani Ltd. present you with the Balance Sheets as on 30th June, 2015 and 2016 and ask you to prepare statements which will show them what has happened to the money which came into the business during the year 2016.

 

Balance sheet as at

	Rs	Rs
Liabilities:	30.06.2015	30.06.2016
Authorised capital (15,000 shares of Rs 100 each)	15,00,000	15,00,000
Paid up capital	10,00,000	14,00,000
Debentures (2016)	4,00,000	-
General Reserves	60,000	40,000
P & L Appropriation A/c	36,000	38,000
Proposed dividends	78,000	72,000
Sundry creditors	76,000	1,12,000
Bank overdraft	69,260	1,29,780
Bills payable	40,000	38,000
Loans on mortgage	-	5,60,000
Total	17,59,260	23,89,780
Assets:
Land and freehold buildings	9,00,000	9,76,000
Plant and machinery	1,44,000	5,94,000
Fixtures and fittings	6,000	5,500
Cash in hand	1,560	1,280
Sundry debtors	1,25,600	1,04,400
Bills receivable	7,600	6,400
Stock	2,44,000	2,38,000
Prepayments	4,500	6,200
Shares in other companies	80,000	2,34,000
Goodwill	2,40,000	2,20,000
Preliminary expenses	6,000	4,000
Total	17,59,260	23,89,780

 

You are given the following additional information:

(a)      Depreciation has been charged (i) on Freehold Buildings @ 2½% p.a. on cost Rs 10, 00,000. (ii) On Machinery and Plant Rs 32,000 (iii) on Fixtures and Fittings @5% on cost Rs 10,000. No depreciation has been written off on newly acquired Building and Plant and Machinery.

(b)      A piece of land costing Rs 1, 00,000 was sold in 2016 for Rs 2, 50,000. The sale proceeds were credited to Land and Buildings.

(c)      Shares in other companies were purchased and dividends amounting to Rs 6,000 declared out of profits made prior to purchase has received and used to write down the investment (shares).

(d)      Goodwill has been written down against General Reserve.

(e)      The proposed dividend for the year ended 30^th June 2015 was paid and, in additions, an interim dividend, Rs 52,000 was paid.

 

Solution: 5 

Illustration: 6

The following is the Balance Sheets of the Android Industries Limited as at 31^st December 2015 and 2016.

Balance sheet as at

	Rs	Rs
Assets:	31.12.2015	31.12.2016
Fixed assets:
Property	1,48,500	1,44,250
Machinery	1,12,950	1,26,200
Goodwill	-	10,000
Current assets:
Stock	1,10,000	92,000
Debtors	86,160	69,430
Cash at bank	1,500	11,000
Pre-payments	3,370	1,000
Total	4,62,480	4,53,880
Liabilities:
Shareholders’ funds:
Paid up capital	2,20,000	2,70,000
Reserves	30,000	40,000
Profit and loss A/c	39,690	41,220
Current liabilities:
Creditors	39,000	41,660
Bills payable	33,790	11,000
Bank overdraft	60,000	-
Provision for taxation	40,000	50,000
Total	4,62,480	4,53,880

 

During the year ended 31^st December, 2016, a divided of Rs 26,000 was paid and assets of another company were purchased for Rs 50,000 payable in fully paid-up shares. Such assets purchased were:

 

Stock: Rs 21,640; Machinery: Rs 18,360; and Goodwill: Rs 10,000. In addition Plant at a cost of Rs 5,650 was purchased during the year; depreciation on Property Rs 4,250; on Machinery Rs 10,760. Income tax during the year amounting to Rs 38,770 was charged to provision for taxation. Net profit for the year before tax was Rs 76,300.

Prepare Funds Flow Statement for the year 2016.

 

 Solution: 6

Illustration: 7

The following are the Balance Sheets of Gamma Industries Limited for the year ending March 31, 2015 and March 31, 2016:

Balance sheet as at

	Rs	Rs
Capital and liabilities:	31.03.2015	31.03.2016
Share capital	6,75,000	7,87,500
General reserves	2,25,000	2,81,250
Capital reserve (profit on sale of investment)	-	11,250
Profit and loss A/c	1,12,500	2,25,000
15% Debentures	3,37,500	2,25,000
Accrued expenses	11,250	13,500
Creditors	1,80,000	2,81,250
Proposed dividends	33,750	38,250
Provision for taxation	78,750	85,500
Total	16,53,750	19,48,500
Assets:
Fixed assets	11,25,000	13,50,000
Less: Accumulated depreciation	2,25,000	2,81,250
Net fixed assets	9,00,000	10,68,750
Long- Term Investments (at cost)	2,02,500	2,02,500
Stock (at cost)	2,25,000	3,03,750
Debtors (net of provision for doubtful debts of Rs 45,000 and Rs 56,250 respectively for 2015 and 2016)	2,53,125	2,75,625
Bills receivable	45,000	73,125
Prepaid expenses	11,250	13,500
Miscellaneous expenditure	16,875	11,250
Total	16,53,750	19,48,500

 

Additional Information:

1.    During the year 2015-16, fixed assets with a net book value of Rs 11,250 (accumulated depreciation, Rs 33,750) was sold for Rs 9,000.

2.    During the year 2015-16, Investments costing Rs 90,000 were sold, and also Investments costing Rs 90,000 were purchased.

3.    Debentures were retired at a Premium of 10%.

4.    Tax of Rs 61,875 was paid for 2015-16.

5.    During the year 2015-16, bad debts of Rs 15,750 were written off against the provision for doubtful debts account.

6.    The proposed dividend for 2007-2008 was paid in 2015-16.

 

Required:

Prepare a Fund Flow Statement for the year ended March 31, 2016.

Solution: 7