Construction and analysis of funds flow statement

by

Carrol

Depending upon the users purpose, the term funds may be used differently. Literally, it means a supply that can be drawn upon. In this sense it is used to mean cash, total current assets or working capital. Normally working capital is considered as the excess of current assets over current liabilities. In case the current assets are more than current liabilities, it is considered as positive net working capital capital and when current assets are lesser than current liabilities, it is considered to be negative working capital.

Funds flow is used to refer to changes in or movement of current assets and current liabilities. This movement is of vital importance in understanding and managing the operations of a business.

Every material transaction changes the position statement (or balance sheet). This in other words implies a dynamic situation involving continuous movement of resources in the business, within the business and out of the business. The complexity of these flows increases with the increasing size and volume of business. Directly or indirectly, all these flows take place in business through the medium of funds.

Working capital and its need:

Working capital is defined as total current assets less current liabilities and in other words, it means that all the assets are held by the business with the objective of conversion into cash (including cash) during an operating cycle of the business. Of these assets, a part is financed by short term credits which are to be met during the operating cycle representing current liabilities. This current assets less current liabilities or working capital implies the amount of resources invested in current assets from sources of finance other than current liabilities. This net amount is also the amount available for use in the business in the form of funds.

When it comes to working capital the functions of the following elements are taken into account:

Cash: It is difficult to perceive cash kept in the vault as an investment. Investment in cash is that amount which is required to be kept on hand to meet the day to day requirements of cash. This amount is determined after taking into account the regularity and amount of inflows of cash, the amount and frequency of outflows, as also the uncertainties related to these. Obviously, as the business grows the need for cash also grows.

Receivables:

In most situations it is necessary to grant credit to the customers. This may be necessary either because of the competition or because of the custom of trade. However, when the customers are granted credit, it implies that they have to finance the cost of materials for the duration of such credit. In other words, it means that the organization is financing for the customers business to the extent of the credit granted. Whenever the business is expanding, the volume of receivables also will expand. The need for financing receivables is not to the full extent of the accounts receivable (sales). In fact it means that the firm is actually financing only to the extent of the cost of goods sold out of the receivables (sales) in question.

Inventory, supplies and prepaid expenses:

There is a certain necessity for carrying inventory. In order to carry on the operations unhindered, the firm should have sufficient amount of merchandise on hand. The quantum they have to keep in store is determined by the availability and regularity of supply lead time for delivery and so on. At the same they should carry some inventory in any case. Similar is the case with non merchandise inventory such as office and factory supplies. The firm is in a position to carry a minimum stock of these to ensure smooth operations. There are several expenses which are to be paid before starting using the services namely, rent, insurance etc.

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