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Statement of Changes in Financial

Position
Share 7
Introduction
Financial statements are most necessary to report financial performance of an
organization. Balance sheet, part of traditional financial statements package,
contains the position of business in terms of development in assets and
liabilities over accounting period. The income statement shows the operating
performance of enterprise, which shows the periods and productive and
commercial activities and its ultimate effect in change in owners' equity.
Although these financial statements are of high importance and shows the
change in assets and liabilities compared between beginning and ending of
the period at single snap-shot, it fails to portray those activities which made
changes or causes change in these financial items.
These additional statements of change in financial position are prepared in
two different ways:
i)Working capital basis as funds flow statement.
ii)Cash basis as cash flow statements.
 
MEANING AND DEFINITION
The funds flow statement are prepared to show the changes in financial
position between two balance sheet dates so that decision maker and analyst
use it more purposefully. The word funds flow statement consists two different
words ‘funds’ and ‘flow’. The funds have different meaning in their places like
cash or working capital or all the other financial resources. Flow means
changes occurred in fund from one specific date to another date under review.
Flow may be inflows and outflows. Thus it can be said that statement
prepared to show the flow of funds on working capital basis is known as funds
flow statement. It shows the different sources of funds and application of fund
in the business.
According to Roy Fouke, “A statement of sources and application of funds is a
technical device designed to analyze the changes in the financial position of a
business enterprise between two dates.”
 
IMPORTANCE
Funds flow statement is an important financial tool, which is required to
analyse the changes in financial position of a firm showing the sources and
applications of its funds. It provides valuable information about the firms
operating, financing and investing activities during a particular period. The
importance of funds flow statement is;
To show the relationship of net profit to the changes in fund from business
operation.
To show the firms ability to generate long term financial to satisfy the
investment.
To predict future funds flow it reports about past fund flow as an aid.
To identify the change in level of current assets investment and current
liabilities financing.
To analyse the changes in working capital level of a firm.
Toshow the relationship of net income to the changes in funds from business
operation.
To determining the firms liability to pay interest and dividends, and pay debt
when they become due.
To show the relationship of net profit to the changes in fund from business
operation.
To show the firms ability to generate long term financial to satisfy the
investment.
 
 
CONCEPT OF FUNDS, FLOW AND STATEMENTS
FUNDS
The word funds refer to the cash, i.e., all financial resources in the business.
The term “funds” has more than one meaning. In funds flow statement,
however, cash is not used as basis, because it concentrates only on changes
in a single asset, cash. Instead, the term funds are used in the broader sense
of working capital, as it focuses on changes in broader category of working
capital.
However, there are two concepts of working capital, i.e gross concept and net
concept. The gross concept of working capital means the form’s total
investment in its current assets. In its net concept, working capital is the
difference between firm’s current assets and current liabilities, such that:
Net working capital = Current Assets – Current Liabilities
The net working capital is thought as a pool of funds to be used in the smooth
operation of the business.
Flow
Here the word “Flow” refers to movement or change of funds in terms of net
working capital. It means inflow or increase and outflow or decrease of funds,
i.e net working capital, as a result of certain financial transactions that have
taken place in the firm during the specific period. All financial transactions
finally affect the balance sheet, but they all do not affect the net working
capital of the firm. The financial transaction which increase current assets or
decrease current liabilities with corresponding decrease in fixed assets or
increase in liabilities and capital create inflow or increase in funds or net
working capital. On the other hand, the transactions which decrease current
assets or increase current liabilities with corresponding increase in fixed
assets or decrease in long-term liabilities and capital cause outflow or
decrease in funds or net working capital.
There are following types of transactions that change(increase and decrease)
of funds:
1.Transactions involving current liabilities and non-current liabilities: In
flow or outflow of funds there involves result of transactions of current
liabilities and non-current liabilities and equity. For instance, issue of
debentures and shares for the payment of sundry creditors will cause inflow of
funds, while drawing bills of exchange for the redemption of debenture and
preference shares will cause outflow of funds.
2.Transactions involving current liabilities and non-current assets:
Changes in funds is also effected by those transactions involving in current
liabilities such as bills payable, sundry creditors, dividends payable , and bank
overdraft and non-current assets also effect.
3.Transactions involving current assets and non-current assets: Those
transactions, which involve current assets such as cash, receivable and
inventory and non-current assets such as fixed assets, intangible assets and
investments result in the flow of funds.
4.Transactions involving current assets and non-current liabilities and
owner’s equity: The transactions, which involver current assets and non-
current liabilities such as along-term loans and owners equity will cause flow
of funds.
5.Transactions involving non-operating receipts and non-operating loss:
The transactions, which involve non-operating receipts and loss result or
decrease of funds. All non-operating receipts increase funds, while on-
operating payments decrease funds.
 
STATEMENT
In simple way “ statement” is a written record which present some kind of
information and facts about some events in a systematic manner. The funds
flow statement is, therefore, a written record of the sources of funds in terms
of net working capital and its application on different  heads during a particular
period of time. It is also called statement of sources and application of funds
or how funds come and where funds gone statement.
Horizontal form
The funds flow statement can be prepared by using the horizontal form. In this
form, sources of funds are shown on the left-hand side and uses or
applications of funds on the right-hand side of the statement as shown below:
Sources of funds Amount Application of funds Amount
Funds from operations……   Loss from operations ……………  
Net decrease in working ……   Net increase in working
capital……….
Issue of common shares…  
Redemption of preference
Issue of preference shares….   shares….
Issue of bonds and debentures…. Redemption of bonds and
Borrowing of long-term loans….. debentures…

Sales of fixed assets …… Repayment of long-term

loans………….
Sales of investments………
Purchase of fixed assets…………..
Non-operating receipts
Purchase of investments…………
 Fixed deposits……………………
Non-operating  payments
Rent…………………………….………
Payments made due to legal
Dividends……………………………… action….
Interest on investments……… Payment of interim & final
Refund of tax…………………………. dividends…
Payment of
tax…………………………….
       

 
Vertical form
Alternatively, the funds flow statement can be prepared by using the vertical
form. In this form sources of funds are shown on the up-side and uses or
applications of funds on the down-side of the statements.
PREPARATION OF FUNDS FLOW STATEMENT
Funds flow statement is prepared mainly with the help of the balance sheet of
any two successive dates. It is prepared by comparing the balance sheets of
the two dates and using the income statement of the year for which the
statement is being prepared. The following are the steps of funds flows
statement:
Step 1:
In the preparation of funds flow statement, the first step is to find out the net
amount of increase or decrease of working capital, as increase in net working
capital is a use of funds and decrease in net working capital is a source. Since
net working capital is excess of current assets over current liabilities, the
increase or decrease in the net working can be found out by comparing the
current assets and current liabilities contained in the balance sheets of two
following dates. For this purpose, a statement is prepared which is called
statement or schedule of changes in net working capital.
The following points are taken into account:
Increase in current assets, increase in net working capital
(↑NWC= ↑CA-CL)
Decrease in a current assets, decrease in net working capital
(↓NWC =↓CA-CL)
Increase in current liabilities, decrease in net working capital
(↓NWC=↑CA-CL)
Decrease in current liabilities, decrease in net working capital
(↑NWC=CA-↓CL)
Using only current account
The statement or schedule of changes in working capital can be prepared by
using only current account, viz. account of current assets and current
liabilities. While preparing the statement, the current assets and current
liabilities of the previous year are compared with those of the current year,
and the changes (increase or decrease) therein are determined. If the total of
increase is more than that of decrease, there is an increase in net working
capital, or vice versa.
Using both current and non-current accounts
The statement or schedule of changes in net working capital can also be
prepared by using both current as well as non-current accounts. Current
account is the account of current assets and current liabilities, and non-current
account is the account of non-current assets and non-current liabilities and
owners equity. Increase in an item of current assets or decrease in an item of
current liabilities or decrease in an item of current assets is credited to current
account. On the other hand, increase in an item of non-current assets or
decrease in an item of non-current liabilities from the previous year to the year
is debited, while increase in an item of non-current liabilities and owners
equity and decrease in an item of non-current assets is credited to non-current
account. The rules for debiting and crediting current an non-current accounts
are ;
Current account
Debit the account, if an item of current asset increases or an item of current
liabilities decreases from that year to this year.
Credit the account, if an item of current liabilities increases or an item of
current assets decreases from that year to this year.
 Non-current accounts
Debit the account, if an item of non-current assets increases or an item of
non-current liabilities decrease from that year to this year.
Credit the account, if an item of non-current liabilities increases or an item of
non-current assets decreases from that year to this year.
Step 2:
Statement of funds from operation
The second step is statement of funds from operation to determine the
amount of funds from business operations. It refers to the funds or loss, which
is generated or suffered in the business as a result of its regular operations
during the period. The funds from operations are an important source of
funds, while loss from operations is one of the important applications of funds.
The funds or loss from operations is determined by adjusting the firm’s net
income in a statement called the statement of funds from operations.
Non-cash expenses such as depreciation and amortization of intangible
assets do not result in actual cash outflow. Non-operating expense are those
which are not treated as regular expenses of the business.
Non-operating and Non-cash Expenses
Depreciation for the year
Amortization of goodwill, copyright, patents, trademarks, preliminary
expenses.
Discount on issue of shares and debentures written off.
Loss on sales of fixed assets or investment.
Loss on revaluation of fixed assets.
Premium on redemption of debentures and preference shares.
Provision for tax during the year
Provision for dividend during the year
Transfer to reserves and funds
Interim dividend paid.

Incomes and gains which are not earned from the normal business operations
are called non-operating incomes. These incomes are included while
ascertaining the business income, but are excluded while determining the
funds from operations. The following are the expenses of the non-operating
incomes.
Non-operating incomes
Gain on sales of fixed assets and investment
Gain on revaluation of fixed assets.
Discount on redemption of debentures and preference shares.
Compensation received
Interest received
Refund of tax
Transfer fees received
Appreciation on fixed assets
 
Preparation of statement of funds from operations
Funds from operations can be determined by using one of the two following
methods:
1.Add back method
Under this method, net profit is taken as the base. All non-operating and non-
cash expenses are added to net profit and non-operating incomes are
deducted.
2.Profit and Loss adjustment account method
Alternatively, funds from operations can also be determined by preparing an
account called profit and loss adjustment account. The profit and loss
adjustment account begins with opening balance of profit on its credit side and
closing balance on the debit side. Instead of opening and closing balance of
profit and loss account, only the amount of net profit for the year can also be
brought down to the debit side of this account. Then the items of non-
operating expenses and non-cash expenses are adjusted to the debit side
and then items of non-operating incomes are adjusted to the credit side to
determine the amount of funds form operations.  It is also called profit and
loss adjustment account because it needs the adjustment for non-operating
and non-cash items for the purpose of calculating funds from operations.
Step 3:
Funds flow statement
After ascertaining the increase or decrease in net working capital and funds or
loss from operations, the next step is to prepare the funds flow statement. The
purpose of preparing the funds flow statement is to know about the funds
obtained and used by the fir. The funds flow statement has two sides. On the
left hand side, the sources of funds are shown and on the right hand side, the
uses or applications of funds are shown.
Sources Amount Application Amount
Funds from   Increase in working  
operation………………………. capital…………………
Decrease in working Loss from
capital……………………. operation………………………….

Issue of Redemption of preference

shares…………………………… shares………

Issue of Redemption of debentures

debentures…………………….. …………………

Increases in long-term Repayment of long-term

liabilities………. liabilities……….

Sale of fixed Purchase of fixed

assets…………………………. assets………………………

Sale of long term Investment

investment…………. made………………………………

Non trading receipts like dividend, Non trading payment like

tax refund, rent dividend……….
etc……………………