What Is Funds Flow Statement?
A funds flow statement is a financial document that tracks the movement of financial resources within an organization over a specific period, typically between two balance sheet dates. It aims to explain how a company's financial position has changed, specifically focusing on the sources from which funds were obtained and the applications to which they were put. This statement falls under the broader category of financial accounting and provides a holistic view of financial changes beyond what an income statement or balance sheet alone might reveal. The "funds" in a funds flow statement were historically often defined as working capital, which is the difference between current assets and current liabilities. The statement helps stakeholders understand how a business managed its financial resources to support its operations, investments, and financing activities.
History and Origin
The concept of tracking the flow of funds has a long history in the United States, with early forms of statements outlining financial transactions appearing as early as 1863 with the Northern Central Railroad. Initially, these statements often focused on changes in cash or broad "funds"34. By the early 20th century, a working capital funds statement gained popularity, defining "funds" as current assets minus accounts payable33.
A significant development in the standardization of financial reporting occurred in 1971 when the Accounting Principles Board (APB) issued Opinion No. 19, "Reporting Changes in Financial Position"32,31. This opinion officially required companies to include a "funds statement," often referred to as a "statement of changes in financial position," as one of the primary financial statements in annual reports. Prior to this, APB Opinion No. 3 in 1963 had also addressed the statement of source and application of funds, which APB Opinion No. 19 later superseded,30. The APB did not specify a single definition of "funds" or a required format, leading to variations in how companies presented these statements, sometimes focusing on cash and other times on working capital29.
However, the lack of a clear definition for "funds" and varying formats eventually led to the funds flow statement being replaced. In 1987, the Financial Accounting Standards Board (FASB), which had replaced the APB in 197328, issued Statement No. 95, "Statement of Cash Flows." This new standard mandated a focus on cash flows, replacing the more general statement of changes in financial position. The shift aimed to provide more consistent and comparable information about a company's cash inflows and outflows27,. Today, financial regulators and standard-setters, including the U.S. Securities and Exchange Commission (SEC), continue to emphasize the importance of robust and transparent cash flow information26.
Key Takeaways
- A funds flow statement explains the changes in a company's financial position between two accounting periods.
- It highlights how financial resources (funds) were generated (sources) and how they were used (applications).
- Historically, "funds" often referred to working capital.
- The statement provides insights into a company's financial health, liquidity, and solvency.
- It was largely superseded by the cash flow statement, which focuses specifically on cash and cash equivalents.
Formula and Calculation
While not a single mathematical formula in the traditional sense, the funds flow statement is essentially an analysis of changes in the balance sheet accounts between two periods. The core concept revolves around the sources and applications of funds, often defined in terms of working capital.
The underlying principle can be summarized as:
To prepare a funds flow statement focusing on working capital, one would typically:
- Prepare a Schedule of Changes in Working Capital: This involves comparing current assets (e.g., cash, accounts receivable, inventory) and current liabilities (e.g., accounts payable, short-term debt) from two different balance sheet dates. An increase in current assets or a decrease in current liabilities increases working capital (a use of funds). Conversely, a decrease in current assets or an increase in current liabilities decreases working capital (a source of funds).
- Identify Non-Current Account Changes: Analyze changes in non-current assets and liabilities, and owner's equity.
- Sources of Funds typically include:
- Funds from operations (e.g., net income adjusted for non-cash items like depreciation).
- Sale of fixed assets or long-term investments.
- Issuance of share capital or long-term debt.
- Uses of Funds typically include:
- Purchase of fixed assets (i.e., capital expenditure).
- Repayment of long-term debt.
- Payment of dividends.
- Redemption of preference shares.
- Sources of Funds typically include:
Interpreting the Funds Flow Statement
Interpreting a funds flow statement involves understanding the interplay between a company's sources and applications of funds over a period. A well-prepared funds flow statement helps in evaluating how effectively management has utilized its financial resources. For instance, if a company's major source of funds is from operations, it suggests strong core business performance. Conversely, if a company heavily relies on issuing new long-term debt or selling fixed assets to meet its operational needs, it might signal underlying financial stress.
Analysts assess whether changes in working capital align with the company's strategic goals. For example, a significant increase in inventory might suggest growth, but it could also indicate slow sales or inefficient management. The statement provides context for changes seen in the balance sheet and income statement, revealing the underlying transactions that caused shifts in financial position, thereby aiding in assessing a company's liquidity and solvency over the long term.
Hypothetical Example
Consider XYZ Corp. for two years, 2023 and 2024.
Schedule of Changes in Working Capital
| Current Assets | 2023 ($) | 2024 ($) | Change ($) |
|---|---|---|---|
| Cash | 50,000 | 60,000 | +10,000 |
| Accounts Receivable | 100,000 | 90,000 | -10,000 |
| Inventory | 80,000 | 110,000 | +30,000 |
| Total Current Assets | 230,000 | 260,000 | +30,000 |
| Current Liabilities | 2023 ($) | 2024 ($) | Change ($) |
|---|---|---|---|
| Accounts Payable | 70,000 | 65,000 | -5,000 |
| Short-term Loan | 20,000 | 30,000 | +10,000 |
| Total Current Liabilities | 90,000 | 95,000 | +5,000 |
Net Change in Working Capital:
Working Capital 2023: $230,000 - $90,000 = $140,000
Working Capital 2024: $260,000 - $95,000 = $165,000
Change in Working Capital: $165,000 - $140,000 = +$25,000 (Increase)
Summary of Funds Flow (Non-current items)
| Item | Change ($) | Source/Use |
|---|---|---|
| Net Profit (adjusted) | +100,000 | Source |
| Sale of Old Equipment | +15,000 | Source |
| Issuance of New Shares | +50,000 | Source |
| Purchase of New Plant | -120,000 | Use |
| Repayment of Long-term Debt | -20,000 | Use |
| Payment of Dividends | -5,000 | Use |
Funds Flow Statement for XYZ Corp. (2024)
| Sources of Funds | Amount ($) |
|---|---|
| Funds from Operations (Net Profit Adjusted) | 100,000 |
| Sale of Old Equipment | 15,000 |
| Issuance of New Equity Shares | 50,000 |
| Total Sources | 165,000 |
| Application of Funds | Amount ($) |
|---|---|
| Purchase of New Plant (Capital expenditure) | 120,000 |
| Repayment of Long-term debt | 20,000 |
| Payment of Dividends | 5,000 |
| Increase in Working Capital | 20,000 |
| Total Applications | 165,000 |
Note: In this simplified example, the increase in working capital directly balances the sources and applications. In practice, the change in working capital is often the balancing figure derived from the sources and applications.
This example shows XYZ Corp. primarily generated funds from its operations and new equity, which were then used for significant fixed assets expansion and debt repayment. The overall working capital also increased, indicating an improved short-term financial position.
Practical Applications
While largely replaced by the cash flow statement for statutory reporting under Generally Accepted Accounting Principles (GAAP), the principles behind a funds flow statement remain relevant in certain analytical contexts. It helps in:
- Understanding Financial Health: By showing the overall movement of funds, it provides insights into a company's long-term financial position and how its assets and liabilities have changed over time25,24.
- Strategic Planning and Budgeting: Analyzing the sources and applications of funds helps management identify funding requirements and plan for future investments and financing activities. It can inform decisions about dividend distribution, reserves, and capital allocation23,22.
- Assessing Working Capital Management: The funds flow statement, particularly when focused on working capital, offers a detailed view of how operational and strategic decisions impact a company's short-term liquidity and efficiency in managing current assets and liabilities21,20.
- Creditworthiness Assessment: Creditors and lenders can use a funds flow analysis to gauge a company's ability to meet its financial obligations and assess its repaying capacity over the long term19,18.
- Macroeconomic Analysis: Beyond individual companies, the broader concept of "flow of funds" is crucial at a national level. The Federal Reserve, for instance, compiles and publishes comprehensive "Flow of Funds Accounts of the United States" (Z.1 Statistical Release) which track the net inflows and outflows of money across various sectors of the national economy. This data is used for economic analysis, to measure economic activity, and to inform fiscal and monetary policy17,,,16.
Limitations and Criticisms
Despite its historical significance and ongoing analytical utility, the funds flow statement has several limitations that led to its eventual replacement by the cash flow statement:
- Ambiguity of "Funds": A primary criticism was the lack of a precise and consistent definition of "funds." While often equating to working capital, this definition could vary, making comparisons between companies difficult15,.
- Historical Nature: The statement is based on past data, which may not accurately reflect a company's current or future financial situation. It provides a historical overview of changes rather than a real-time assessment of financial health14,13,12.
- Lack of Cash Focus: Perhaps the most significant limitation is that a funds flow statement, especially one based on working capital, does not directly reveal a company's actual cash position or its ability to generate and manage cash11,10. A company could have a positive change in working capital but still face a cash shortage.
- Limited Detail on Non-Cash Transactions: While non-cash items like depreciation are adjusted for in deriving funds from operations, the statement generally provides less detailed information about specific non-cash transactions or how they impact overall profitability9.
- Non-Standardized: Unlike the cash flow statement, which is a mandatory and highly standardized report under current accounting standards, the funds flow statement is not universally required, leading to inconsistencies in reporting if voluntarily prepared8,7.
These drawbacks ultimately contributed to the move towards the more precise and universally applicable cash flow statement.
Funds Flow Statement vs. Cash Flow Statement
The terms "funds flow" and "cash flow" are often confused, but they represent distinct concepts in financial accounting. The key differences lie in their focus, the definition of "funds," and their primary purpose:
| Feature | Funds Flow Statement | Cash Flow Statement |
|---|---|---|
| Primary Focus | Changes in a company's overall financial position, often centered on working capital. It shows the movement of financial resources.6 | Actual cash inflows and outflows over a period. It focuses on liquidity. |
| Definition of "Funds" | Historically, "funds" could broadly mean working capital (current assets minus current liabilities).5, | "Cash" refers to cash and cash equivalents.,4 |
| Reporting Requirement | Was formally required by APB Opinion No. 19 from 1971-1987 in the U.S.; largely superseded thereafter. | Mandated by Generally Accepted Accounting Principles (GAAP) and IFRS since 1988 in the U.S., |
| Classification of Activities | Did not typically classify activities into operating, investing, and financing sections explicitly.3 | Categorizes cash flows into operating, investing, and financing activities. |
| Purpose | Provides insights into long-term financial changes and resource allocation. Helps with long-term financial planning.2 | Assesses short-term liquidity and a company's ability to generate cash to meet immediate obligations.1 |
While the funds flow statement analyzes broader financial shifts and changes in working capital, the cash flow statement provides a clearer, more immediate picture of a company's ability to generate and use cash, which is critical for short-term viability.
FAQs
What is the main purpose of a funds flow statement?
The main purpose of a funds flow statement is to explain how a company's financial position changed between two specific dates. It details where financial resources (funds) came from (sources) and how they were used (applications) within the business.
Why is the funds flow statement not as commonly used today?
The funds flow statement, particularly in its historical form focusing on working capital, was largely replaced by the cash flow statement because the latter provides a more precise and universally understood picture of actual cash movements. Regulators and investors preferred the clarity of cash flows for assessing a company's liquidity.
What is "funds from operations" in a funds flow statement?
"Funds from operations" represents the funds generated by a company's core business activities. It typically starts with net income and then adjusts for non-cash expenses, such as depreciation, and gains or losses from the sale of non-current assets, to reflect the actual funds generated from day-to-day operations.
Does a funds flow statement show profit?
No, a funds flow statement does not directly show profit. Profit is reported on the income statement. However, net profit (or loss) from the income statement is a starting point for calculating "funds from operations," which is a key source of funds in the statement.
Can a funds flow statement predict future financial health?
While a funds flow statement provides valuable historical context about how a company managed its resources, it is based on past data. Therefore, it does not directly predict future cash flows or financial performance. For forward-looking analysis and short-term liquidity assessment, the cash flow statement is generally more insightful.