UNIT III

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UNIT III FUND FLOW AND CASH FLOW ANALYSIS,
BUDGETARY CONTROL

Meaning and Definition Merits and Demerits Differences

between fund flow and cash flow analysis Fund Flow and
Cash Flow Analysis (Problems)

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The concept of Funds
The term fund is a highly disputed one-conveying
different meaning to different people.

It means spans from total resources of a concern to

cash and near cash items.

According to IAS-7, the term Fund generally refers to

cash, to cash equivalent or to working capital.

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Meaning from three concepts
Statement of changes in financial position
This statement is based on the widest interpretation of
funds as all resources. It measures changes in both current and
non-current items.
Cash flow statement
This statement is based on cash concept of funds or the
narrow interpretation of funds. It measures the cash inflows and
outflows resulting from al business transactions.
Fund flow statement
This statement is based on the working capital concept of
funds. It measures the inflows and outflows of working capital
resulting from different business transactions.

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Fund Flow
Flow means change. Funds is interpreted as working
capital.

Thus fund flow is change in working capital.

It measures and presents in an analytical manner the

summarized version of the numerous flows of funds
for a specific period.

Flow can be inflow or outflow of working capital.

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Working capital
Gross working capital is the total of current assets.
Circulating capital is the amount revolving in the cycle
of cash-inventories-receivables and cash.
Net working capital is the excess of current assets over
current liabilities.
Fund flow statement is generally prepared and
interpreted on the basis on net working capital.

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Current assets
All those assets which are converted into cash in the
normal course of business within one year or within
the operating cycle are known as current assets.

The intention in acquiring such assets must be to

convert them into cash. The conversion has to take
place in the normal course of business.

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Categories of Current Assets
Cash and near cash items.
Cash in hand
Cash at bank
Fixed deposit in banks.
Accounts receivable.
Trade debtors
Non-trade debtors
Bills receivable

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Contd.,
Inventories.
Stocks of raw materials.
work-in-progress.
Finished goods.
Advances recoverable in cash.
Advances and loans to employees.
advances to suppliers.
Prepaid expenses etc., like prepaid insurance.

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Current liabilities
All those liabilities which are payable in cash in the
normal course of business within a period of one year
or within the operating cycle are called current
liabilities.

The period of repayment should not exceed one year in

the operating cycle.

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Categories of Current liabilities
Accounts payable
Bills payable
Notes payable
Trade creditors
Borrowings on short term basis
Temporary bank overdraft
Short-term bank loans
Private borrowing repayable within one
year

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Contd.,
Outstanding expenses.
Expenses for which payment has become
due.
Income received in advance.
Money received in advance for service to be
rendered or goods to be supplied in future.
Tax payable and dividend payable.
When tax is assessed, it becomes a liability,
similarly dividend is declared as a liability.

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Importance of Fund Flow
Statement
It provides a detailed analysis and understanding of
changes in the distribution of financial resources
between two balance sheet dates.
It shows how the funds were obtained and used during
a period.
The sources from which funds were obtained are
useful in computation of cost of capital of the
business.
It throws light on the financial consequences of
business operations.
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Contd.,
It can be compared with the relevant budgets to assess
the usage of funds as per plans.
Rearrangements of capital structure, formulating long
term financial plans and policies etc., are facilitated by
fund flow analysis.
It gives indication of any weakness or strength in the
general financial position of a firm.
a detailed analysis of sources of funds in the past acts
as a guide for obtaining funds for future requirements.

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Limitations of Fund Flow Statement
It is historical in nature. It shows what happened in
the past.
It is nothing but secondary data. Its accuracy and
reliability depend on the accounting department.
It is a summarized presentation of figures and cannot
provide information about changes on a continuous
basis.
It ignores transactions between long term assets and
liabilities.

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Distinction between Fund Flow and
Balance Sheet
Funds Flow Statement Balance Sheet
It shows changes in working capital It shows the position of assets and
between two balance sheet dates. liabilities on specific dates.

It aims at presenting flow of funds It aims at depicting the financial

over a period position of a business

It is prepared after the financial It is prepared after the income

accounts are completed statement is completed

It shows only those items which cause It shows the real personal accounts of
changes in working capital a business, reflected in the assets and
liabilities

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Preparation of Fund Flow
Statement
It reflects the change in working capital during a
period through those transactions which affect the
funds-termed as cross transactions.

It is preferable to prepare the working capital

statement which shows the complete details of the
contribution of each item of current asset and current
liability towards the overall change in the working
capital.

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Working Capital Statement or
Schedule of changes in Working
Capital
The statement of change in working capital is
concerned with the current assets and current
liabilities alone, as they are shown in the balance
sheet of the current year and the previous year.

It is possible that working capital might have increased

during a period or it might have decreased. The
working capital statement shows such increase or
decrease in the working capital as the final result.

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Principles for the preparation of
Working Capital
Increase in Current Asset Increases Working Capital

Decrease in Current Asset Decreases Working

Capital

Increase in Current Liability Decreases in Working

Capital

Decrease in Current Liability Increases in Working

Capital

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Fund Flow Statement
It is composed of two categories of items, Sources of
funds and application of funds.

It is necessary to ascertain them in order to prepare the

funds flow statement.

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Sources of Funds
Internal sources
Funds from operations
External sources
Issue of equity shares
Issue of preference shares
Issue of Debentures
Sale of fixed assets
Sale of long term investments

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Applications or uses of funds
Purchase of fixed assets.
Purchase of long term investments.
Redemption of preference shares.
Redemption of debentures.
Repayment of long-term loans, bank loans and public
deposits.
Payment of dividend.
Payment of tax liability.
Outflow of funds on account of operations

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Cash Flow
The term cash in the context of cash flow analysis
includes the cash balance and the bank balance of a
business unit.
Movements of cash are of vital importance to the
management.
The short term liquidity and short term solvency
positions of a firm are dependent on its cash flows.
It reveals that for even high profitable firms
experiences acute cash shortages.

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Cash Flow Statement
It is a statement which portrays the changes in the
cash position between two accounting periods.
The detailed analysis provided in such a statement
provides a clear insight to the management about the
different sources of cash inflows and the different uses
or applications for which cash is needed.
It helps in taking short term financial decisions and
also in the preparation of cash budget for the next
period.

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Advantages
Historical analysis as guide to forecasting.
Effective cash management.
Formulation of financial policies.
Preparations of cash budget.
Short term financial decisions.
Liquidity position.
Revelations.

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Limitations
It discloses inflows and outflows of cash alone. Thus
its scope is very limited compared to funds flow
statement.
It reveals the cash balance, but it can be easily altered
by postponing payments for purchases or delaying
collection of receivables etc.,
It cannot provide a comprehensive picture of a firms
financial position.

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Preparation of Cash Flow
It is prepared on the same lines as the funds flow
statement but strictly restricted to sources and uses of
cash.
It starts with the cash and bank balances at the
commencement of the period.
If there is bank overdraft and cash balance, the net
cash balance or net bank overdraft becomes the
starting point.

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Principles for the preparation of
Cash Flow Statement
Increase in Current Asset Decreases Cash

Decrease in Current Asset Increases Cash

Increase in Current Liability Increases Cash

Decrease in Current Liability Decreases Cash

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Differences between Funds Flow
and Cash Flow Analysis
Funds Flow Analysis Cash Flow Analysis

It is prepared on the basis of working It is prepared on the basis of cash

capital concepts concept
It is based on accrual concept It is based on cash concept

It shows the various causes for change It reveals the causes for change in the
in the working capital cash position over the same period
It is more useful in decision making in It is more useful in the short run
a long run
It reveals short term solvency It cannot reveal short term solvency
clearly
Long term utility Short term utility
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