FINANCIAL ANALYSIS AND PLANNING
3.752.9.5 Importance of Funds Flow Statement
2.9.7 Funds Flow Statement vs. Cash Flow Statement
Both funds flow and cash flow statements are used in analysis of past transactions of a business firm. The differences between these two statements are given below:
(a) Funds flow statement is based on the accrual accounting system. In case of preparation of cash flow statements all transactions effecting the cash or cash equivalents only is taken into consideration.
(b) Funds flow statement analyses the sources and application of funds of long-term nature and the net increase or decrease in long-term funds will be reflected on the working capital of the firm. The cash flow statement will only consider the increase or decrease in current assets and current liabilities in calculating the cash flow of funds from operations.
(c) Funds Flow analysis is more useful for long range financial planning. Cash flow analysis is more useful for identifying and correcting the current liquidity problems of the firm.
(d) Funds flow statement tallies the funds generated from various sources with various uses to which they are put. Cash flow statement starts with the opening balance of cash and reach to the closing balance of cash by proceeding through sources and uses.
Illustration 7
Given below is the Balance Sheet of X Ltd. as on 31st March, 2005, 2006 and 2007.
31st March 31st March
Liabilities 2005 2006 2007 Assets 2005 2006 2007
(Rs. in Lacs) (Rs. in Lacs)
Share Capital 70,00 75,00 75,00 Plant &
Machinery 80,00 110,00 130,00
Reserve 12,00 16,00 25,00 Investments 35,00 30,00 45,00 Profit & Loss A/c 6,00 7,00 9,00 Stock 15,00 15,00 20,00
12% Debentures 10,00 5,00 10,00 Debtors 5,00 5,50 5,00 Cash Credit 5,00 7,00 12,00 Cash at Bank 5,00 3,00 3,25 Creditors 12,00 14,00 18,00
Tax Provision 11,00 17,00 28,00 Proposed Div. 14,00 22,50 26,25
140,00 163,50 203,25 140,00 163,50 203,25 Other Information:
(i) Depreciation:2004-2005 Rs. 500 lacs; 2005-06 Rs. 700 lacs; and 2006-07 Rs. 775 lacs.
(ii) In 2005-06 a part of the 12% debentures was converted into equity at par.
(iii) In the last three years there was no sale of fixed assets.
Financial Analysis and Planning
3.77
(iv) In 2005-06 investment costing Rs. 500 lacs was sold for Rs. 510 lacs. The management is confused on the deteriorating liquidity position despite good profit earned by the enterprise. Identify the reasons. Fund Flow Analysis may be adopted for this purpose.
Solution
(1) Working Capital of X Ltd. during 2004-05, 2005-06 and 2006-07
2004-05 2005-06 2006-07 (Rs. in Lacs) Current Assets :
Stock 15,00 15,00 20,00
Debtors 5,00 5,50 5,00
Cash at Bank 5,00 3,00 3,25
25,00 23,50 28,25
Less : Current Liabilities :
Cash Credit 5,00 7,00 12,00
Creditors 12,00 14,00 18,00
17,00 21,00 30,00
Working Capital 8,00 2,50 (1,75)
Decrease in Working Capital — 5,50 4,25
So working capital decreased by Rs. 550 lacs in 2005-06 and Rs. 425 lacs in 2006-07 (2) Profit earned and funds from operations
2005-06 2006-07 Profit during the year : (Rs. in Lacs)
Increase in Profit & Loss A/c 1,00 2,00
Increase in Reserve 4,00 9,00
Tax provision 17,00 28,00
Proposed Dividend 22,50 26,25
44,50 65,25
Less : Profit on sale of Investment (10) — Add : Depreciation 7,00 7,75
Fund from operations 51,40 73,00
X Ltd. earned Rs. 44,50 lacs profit and Rs. 51,40 Lacs fund in 2005-06. It earned Rs. 62,25 lacs profit and Rs. 73,00 lacs fund in 2006-07.
(3) Fund Flow Statements 2005-06 2006-07
(Rs. in Lacs) Sources:
Fund from operations 51,40 73,00
Issue of 12% debentures — 5,00
Sale of investments 5,10 _____
56,50 78,00
Applications:
Purchase of Plant and Machinery 37,00 27,75
Purchase of Investments — 15,00
Tax payment 11,00 17,00
Dividend payment 14,00 22,50
62,00 82,25
Decrease in Working Capital 5,50 4,25
Comments:
(1) It appears (Rs. 25,00 lacs) that 48.64% (Rs. 51,40 lacs) × 100 of the fund generated during 2005-06 were used to pay tax and dividend. The percentage became still higher (54.11%)
00 100 , 73 . Rs
50 , 39 .
Rs × in 2006-07
(2) In 2005-06 the balance of the fund generated was 51.36% (100 – 48.64%)which is used to finance purchase of plant and machinery. Sources of finance for long-term investment were:
Fund from Operations 71.35% (Rs. 26,40 lacs/Rs. 37,00 lacs) ×100 Sale of Investments 13.78% (Rs. 5,10 lacs / Rs. 37,00 lacs) ×100 Working Capital 14.87% (Rs. 5,50 lacs / Rs. 37,00 lacs) ×100 Thus inadequate long-term fund to finance purchase of plant and machinery deteriorated working capital position. Also the management proposed 30% dividend in 2005-06.
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So, liquidity deterioration in 2005-06 was due to (a) deployment of working capital in long term investment and (b) high rate of dividend.
(3) In 2006-07, fund generation was 42.02% more. But dividend was increased from 20% to 30% which absorbed about 30.83% of funds generated. Tax paid to fund generated was also increased from 21.40% to 23.29%, Investment in Plant &
Machinery (net of collection by issue of debentures) was 31.16% of the fund generated. Thus margin of 14.73 would remain had there been no investment outside business. This amounts to Rs. 10.75 lacs. So outside investment caused liquidity deterioration in 2006-07.
Illustration 8
Given below are the balance sheets of Spark Company for the years ending 31st July, 2006 and 31st July, 2007.
Balance Sheet for the year ending on 31st July
(Rs.) (Rs.) 2006 2007 CAPITAL AND LIABILITIES
Share capital 3,00,000 3,50,000
General reserve 1,00,000 1,25,000
Capital reserve (profit on sale of investment) - 5,000
Profit and loss account 50,000 1,00,000
15% Debentures 1,50,000 1,00,000
Accrued expenses 5,000 6,000
Creditors 80,000 1,25,000
Provision for dividend 15,000 17,000
Provision for taxation 35,000 38,000
Total 7,35,000 8,66,000 Assets
Fixed Assets 5,00,000 6,00,000
Less: Accumulated depreciation 1,00,000 1,25,000
Net fixed assets 4,00,000 4,75,000
Long-term investments (at cost) 90,000 90,000
Stock (at cost) 1,00,000 1,35,000 Debtors (net of provisions for doubtful debts of Rs.
20,000 and Rs. 25,000 respectively for 2003 and 2004) 1,12,500 1,22,500
Bills receivables 20,000 32,500
Prepaid expenses 5,000 6,000
Miscellaneous expenditure 7,500 5,000
Total 7,35,000 8,66,000 Additional Information:
(i) During the year 2007, fixed asset with a net book value of Rs. 5,000 (accumulated depreciation Rs. 15,000) was sold for Rs. 4,000.
(ii) During the year 2007, investments costing Rs. 40,000 were sold, and also investments costing Rs. 40,000 were purchased.
(iii) Debentures were retired at a premium of 10 percent.
(iv) Tax of Rs. 27,500 was paid for 2006.
(v) During 2007, bad debts of Rs. 7,000 were written off against the provision for doubtful debt account.
(vi) The proposed dividend for 2006 was paid in 2007.
You are required to prepare a funds flow statement (i.e. statement of changes in financial position on working capital basis) for the year ended 31st July, 2007.
Solution
Funds Flow Statement for the year ended 31st July, 2007
(Rs.) Sources
Working capital from operations 1,71,000
Sale of fixed asset 4,000
Sale of investments 45,000
Share capital issued 50,000
Total Funds Provided 2,70,000
Financial Analysis and Planning
3.81
Uses
Purchase of fixed assets 1,20,000
Purchase of investments 40,000
Payment of debentures (at a premium of 10%) 55,000
Payment of dividend 15,000
Payment of taxes 27,500
Total Funds Applied 2,57,500
Increase in Working Capital 12,500
Working Notes:
(a) Funds from Operations:
Rs.
Profit and loss balance on 31st July, 2007 1,00,000
Add: Depreciation 40,000
Loss on sale of asset 1,000
Misc. expenditure written off 2,500
Transfer to reserve 25,000
Premium on redemption of debentures 5,000
Provision for dividend 17,000
Provision for taxation 30,500
2,21,000 Less: Profit and loss balance on 31st July, 2006 50,000
Funds from Operations 1,71,000
(b) Depreciation for the year 2007 was Rs. 40,000. The accumulated depreciation on 31st July, 2006 was Rs. 1,00,000 of which Rs. 15,000 was written off during the year on account of sale of asset. Thus, the balance on 31st July, 2007 should have been Rs. 85,000. Since the balance is Rs. 1,25,000, the company would have provided a depreciation of Rs. 40,000 (i.e. Rs. 1,25,000 − Rs. 85,000) during the year 2007.
(c) Fixed assets were of Rs. 5,00,000 in 2006. With the sale of a fixed asset costing Rs.
20,000 (i.e. Rs. 5,000 + Rs. 15,000) this balance should have been Rs. 4,80,000. But the balance on 31st July, 2007 is Rs. 6,00,000. This means fixed assets of Rs. 1,20,000 were acquired during the year.
(d) Profit on the sale of investment, Rs. 5,000 has been credited to capital reserve account.
It implies that investments were sold for Rs. 45,000 (i.e. Rs. 40,000 + Rs. 5,000).
The provision for taxation during the year 2007 is Rs. 30,500 [i.e. Rs. 38,000 − (Rs. 35,000 − Rs. 27,500)].
Bad debts written off against the provision account have no significance for funds flow statement, as they do not affect working capital.
Illustration 9
The summarized Balance Sheet of Xansa Ltd. as on 31-12-005 and 31-12-2006 are as follows:
31-12-2005 31-12-2006
Assets
Fixed assets at cost 8,00,000 9,50,000
Less: Depreciation 2,30,000 2,90,000
Net 5,70,000 6,60,000
Investments 1,00,000 80,000
Current Assets 2,80,000 3,30,000
Preliminary expenses 20,000 10,000
9,70,000 10,80,000
Liabilities
Share Capital 3,00,000 4,00,000
Capital reserve − 10,000
General reserve 1,70,000 2,00,000
Profit & Loss account 60,000 75,000
Debentures 2,00,000 1,40,000
Sundry Creditors 1,20,000 1,30,000
Tax Provision 90,000 85,000
Proposed dividend 30,000 36,000
Unpaid dividend − 4,000
9,70,000 10,80,000
During 2006, the company –
(a) Sold one machine for Rs. 25,000 the cost of the machine was Rs. 64,000 and depreciation provided for it amounted to Rs. 35,000.
(b) Provided Rs. 95,000 as depreciation.
Financial Analysis and Planning
3.83 (c) Redeemed 30% of debentures at Rs. 103.
(d) Sold investments at profit and credited to capital reserve; and
(e) Decided to value the stock at cost, whereas earlier the practice was to value stock at cost less 10%. The stock according to books on 31-12-2005 was Rs. 54,000 and stock on 31-12-2006 was Rs. 75,000, which was correctly valued at cost.
You are required to prepare the following statements:
(i) Funds from Operations
(ii) Sources and application of funds and statement of changes in working capital.
(iii) Fixed assets account and loss on sale of machinery account.
Solution Working Notes:
Fixed Assets A/c
Rs. Rs.
To Balance b/d 8,00,000 By Sale of Machinery A/c 64,000 To Cash Purchases (Balancing
figure) 2,14,000 By Balance c/d 9,50,000
10,14,000 10,14,000
Sale on Machinery A/c
Rs. Rs.
To Fixed Assets (original cost) 64,000 By Provision for Depreciation
(provided till date) 35,000
By Cash (sales) 25,000
By Loss (P & L A/c) 4,000
64,000 64,000
Provision for Depreciation of Fixed Assets A/c
Rs. Rs.
To Sale of Machinery a/c 35,000 By Balance b/d 2,30,000 To Balance c/d 2,90,000 By Profit & Loss A/c 95,000
3,25,000 3,25,000
Statement of Funds generated from Operations
(Rs.)
Profit & Loss A/c (Carried forward to B/S) 75,000 Add: Fixed Assets (loss on sales) 4,000
Depreciation 95,000
Premium on redemption of Debentures (60,000×3/100) 1,800
Preliminary expenses written off 10,000
Provision for Income-tax 85,000
Proposed Dividend 36,000
Transfer to General Reserve 30,000 2,61,800
3,36,800
Less:
Profit and Loss A/c Opening Balance 60,000
Increase in Opening Stock value (54,000×10/90) 6,000 66,000
Funds generated from operation 2,70,800
Funds flow Statement of Xansa Ltd. for the year ended 31-12-2006
(Rs.) Sources of Funds:
Issue of Shares 1,00,000
Sale of Investments 30,000
Sale of Machinery 25,000
Funds generated from operations 2,70,800
Total 4,25,800
Application of Funds:
Purchase of Fixed Assets 2,14,000
Redemption of Debentures with 3% Premium i.e., (60,000×103/100) 61,800 Dividend paid for the last year (Rs. 30,000 – Rs. 4,000 unpaid dividend) 26,000
Taxes paid belonging to last year 90,000
Increase in Working Capital (balancing figure) 34,000
Total 4,25,800
Financial Analysis and Planning
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Statement of Changes in Working Capital
Particulars 2005 2006 + -
Current Assets 2,86,000 3,30,000 44,000 -
(including 6,000 on account of
revaluation of stock)
Current Liabilities 1,20,000 1,30,000 - 10,000
Net Working capital 1,66,000 2,00,000
Increase in Working Capital 34,000 - - 34,000
2,00,000 2,00,000 44,000 44,000
Self Examination Questions A. Objective Type Questions 1. The term cash includes
(a) Cash and Bank Balances (b) All the Current Assets (c) All the Current Liabilities (d) None of the above.
2. “Cash flow statement reveals the effects of transactions involving movement of cash”.
This statement is (a) Correct (b) Incorrect (c) Partially Correct (d) Irrelevant.
3. The Preparation of Cash flow statement is governed by AS-3 (Revised). This statement is
(a) False (b) True (c) Partially true (d) Cannot say.
4. A cash flow statement is like an income statement (a) I agree
(b) I disagree (c) I cannot say
(d) The statement is ambiguous.
5. Funds flow statement and cash flow statement are one and the same (a) True
(b) False (c) I cannot say
(d) The statement is irrelevant.
6. Increase in the amount of bills payable results in (a) Increase in cash
(b) Decrease in cash (c) No change in cash (d) I cannot say.
7. Cash from operations is equal to
(a) Net profit plus increase in outstanding expenses (b) Net profit plus increase in debtors
(c) Net profit plus increase in stock (d) None of the above.
8. Cash equivalents are short term highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.
(a) I agree (b) I do not agree (c) I cannot say (d) Irrelevant.
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9. For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of
(a) Gold (b) Cash (c) Investment (d) Real estate.
10. Non-cash transactions
(a) Form part of cash flow statement (b) Do not form part of cash flow statement
(c) May or may not form part of cash flow statement
(d) I cannot say whether they are part of cash flow statement.
Answers to Objective Type Questions
1. (a); 2. (a); 3. (b) 4. (b); 5. (b); 6. (a); 7. (a); 8. (a); 9. (b); 10. (a);
B. Long Answer Type Questions
1. What is a cash flow statement? Discuss briefly its major classification.
2. Distinguish between Funds flow statement and Cash flow statement.
3. Outline the Importance of cash flow statement in managing cash flows of a business organization.
4. Explain the technique of preparing a cash flow statement with imaginary figures.
5. Explain the difference between direct and indirect methods of reporting cash flows from operating activities as per AS-3 (Revised).
C. Practical Problems
1. From the following Summary Cash Account of X Ltd. prepare Cash Flow Statement for the year ended 31st March, 2006 in accordance with AS-3 (Revised) using the direct method. The Company does not have any cash equivalents.
Summary Cash Account for the year ended 31.3.2006
Balance on 1-4-2005 50 Payment of Suppliers 2,000 Issue of Equity Share 300 Purchase of Fixed Assets 200 Receipts from Customers 2,800 Overhead expense 200
Sale of Fixed Assets 100 Wags and Salaries 100
Taxation 250
Dividend 50
Repayment of Bank Loan 300
Balance on 31-3-2006 150
3,250 3,250
2. Ms. Jyoti of Star Oils Limited has collected the following information for the preparation of cash flow statement for the year 2005:
(Rs. in lakhs)
Net Profit 25,000
Dividend (including dividend tax) paid 8,535
Provision for Income-tax 5,000
Income-tax paid during the year 4,248
Loss on sale of assets (net) 40
Book value of the assets sold 185
Depreciation charged to Profit & Loss Account 20,000
Amortisation of Capital grant 6
Profit on sale of Investments 100
Carrying amount of Investment sold 27,765
Interest income on investments 2,506
Interest expenses 10,000
Interest paid during the year 10,520
Increase in Working Capital (excluding Cash & Bank balance) 56,075
Purchase of fixed assets 14,560
Investment in joint venture 3,850
Expenditure on construction work-in-progress 34,740
Proceeds from calls in arrear 2
Receipt of grant for capital projects 12
Proceeds from long-term borrowings 25,980
Proceeds from short-term borrowings 20,575
Opening cash and Bank balance 5,003
Closing Cash and Bank balance 6,988
Financial Analysis and Planning
3.89
Required: Prepare the Cash Flow Statement for the year 2005 in accordance with AS-3, Cash Flow Statements issued by the Institute of Chartered Accountants of India. (Make necessary assumption).
3. The summarized Balance Sheets of XYZ Ltd. as at 31st December, 2004 and 2005 are given below:
(Rs.)
Particulars 2004 2005
Liabilities
Share capital 4,50,000 4,50,000
General Reserve 3,00,000 3,10,000
Profit and Loss account 56,000 68,000
Creditors 1,68,000 1,34,000
Provision for tax 75,000 10,000
Mortgage loan --- 2,70,000
10,49,000 12,42,000
Assets
Fixed assets 4,00,000 3,20,000
Investments 50,000 60,000
Stock 2,40,000 2,10,000
Debtors 2,10,000 4,55,000
Bank 1,49,000 1,97,000
10,49,000 12,42,000
Additional information:
(a) Investments costing Rs.8,000 were sold during the year 2005 for Rs.8,500.
(b) Provision for tax made during the year was Rs.9,000.
(c) During the year, part of the fixed assets costing Rs.10,000 was sold for Rs.12,000 and the profit was included in profit and loss account.
(d) Dividend paid during the year amounted to Rs.40,000.
You are required to prepare a Statement of Sources and Uses of cash.
4. The following are the changes in the account balances taken from the Balance Sheets of P Q Ltd. as at the beginning and end of the year:
Changes in Rupees in debit or credit
Equity share capital 30,000 shares of Rs.10 each issued and fully paid 0
Capital reserve (49,200)
8% debentures (50,000)
Debenture discount 1,000
Freehold property at cost/revaluation 43,000
Plant and machinery at cost 60,000
Depreciation on plant and machinery (14,400)
Debtors 50,000
Stock and work-in-progress 38,500
Creditors (11,800)
Net profit for the year (76,500)
Dividend paid in respect of earlier year 30,000
Provision for doubtful debts (3,300)
Trade investments at cost 47,000
Bank (64,300) 0 You are informed that:
(a) Capital reserve as at the end of the year represented realized profits on sale of one freehold property together with surplus arising on the revaluation of balance of freehold properties.
(b) During the year plant costing Rs.18,000 against which depreciation provision of Rs.13,500 was lying was sold for Rs.7,000.
(c) During the middle of the year Rs.50,000 debentures were issued for cash at a discount of Rs.1,000.
(d) The net profit for the year was after crediting the profit on sale of plant and charging debenture interest.
You are required to prepare a cash flow statement which will explain, why bank borrowing has increased by Rs.64,300 during the year end. Ignore taxation.
5. Given below are the condensed Balance Sheets of M.M. Kusha Ltd. for two years and the statement of Profit and Loss for one year:
Financial Analysis and Planning
3.91
(Rs. lakhs)
As at 31st March 2005 2004
Share Capital
In Equity shares of Rs.100 each 150 110
10% Redeemable Preference Shares of Rs.100 each 10 40
Capital Redemption Reserve 10 --
General Reserve 15 10
Profit and Loss Account balance 30 20
8% Debentures with Convertible Option 20 40
Other Term Loans 15 30
250 250
Fixed assets less Depreciation 130 100
Long-Term Investments 40 50
Working Capital 80 100
250 250
Statement of Profit and Loss for the year ended 31st March, 2005
(Rs. lakhs)
Sales 600
Less: Cost of sale 400
200
Establishment charges 30
Selling and distribution expenses 60
Interest expenses 5
Loss on sale of equipment (Book value Rs.40 lakhs) 15 110
90
Interest income 4
Dividend income 2
Foreign exchange gain 10
Damages received for loss of reputation 14 30
120
Depreciation 50
70
Taxation 30
40
Dividends 15
Net Profit carried to Balance Sheet 25
You are informed by the accountant that ledgers relating to debtors, creditors and stock for both the years were seized by the income-tax authorities and it would take at least two months to obtain copies of the same. However, he is able to furnish the following data:
(Rs. lakhs)
Particulars 2005 2004
Dividend receivable 2 4
Interest receivable 3 2
Cash on hand and with bank 7 10
Investments maturing within two months 3 2
15 18
Interest payable 4 5
Taxes payable 6 3
10 8
Current ratio 1.5 1.4
Acid test ratio 1.1 0.8
It is also gathered that debenture-holders owning 50% of the debentures outstanding as on 31-3-2004 exercised the option for conversion into equity shares during the financial year and the same was put through.
You are required to prepare a direct method cash flow statement for the financial year, 2005 in accordance with Accounting Standard (AS 3) revised.