Funds Flow

Statement

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2 Financial Management

Funds From Business Operations

The profit loss figure, as shown in the profit and loss account of the firm, per se does not indicate
the quantum of working capital provided by business operations because the revenues and expenses
shown do not run parallel to the flow of working capital. The profit and loss account contains a
variety of write-offs and other adjustments which do not involve any corresponding movement of
funds. Therefore, appropriate adjustments are to be made to the profit disclosed by the profit and
loss account to arrive at the funds from business operations. For this purpose: (i) all such expenses
which have been deducted from revenue but do not reduce working capital are to be added back,
(ii) such items which have been added to revenue but have not contributed to the working capital
are to be subtracted, and (iii) all such revenues which are not directly caused by business operations should also be deducted and shown separately in the statement.
The items requiring adjustment are listed in Exhibit 3.1:
Exhibit 3.1 Adjustment to Profit
(A)
(B)




(C)

Net income (or loss) as shown by the profit and loss account
Add: Depreciation expenses;
Amortisation of goodwill, patents and other intangible assets;
Amortisation of discount on debentures or share issue expenses;
Amortisation of extraordinary losses occurred in previous years;
Loss on sale of non-current assets;
Less: Amortisation of premium received on debentures;
Profit on sale of equipment;
Profit on revaluation of non-current assets;
Dividends and interest on investments (reported separately).
(A + B C) = Funds from business operations.

An Alternative Method of Estimating Funds from Operations

The alternative method of measuring funds provided by business operations, in actual practice, is
by recasting the profit and loss account itself. To be specific, the profit and loss account should be
prepared afresh so as to incorporate (i) only business revenues providing working capital on the
income side (leaving the items which are to be deducted as per Exhibit 3.1); and (ii) only those
operating expenses which involve the use of working capital (leaving the items which are to be
added as per Exhibit 3.1). The balancing figure of such a statement would represent, then, the
Exhibit 3.2 Adjusted Profit and Loss Account
(A) Sales Revenues
(B) Less: Expenses using working capital:


Cost of goods sold (excluding depreciation)

Wages and salary expenses


Manufacturing expenses


Advertising expenses


Insurance expenses


Office expenses

Other operating expenses

Interest

Income taxes

(A B) = Funds from business operations

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Fund Flow Statement 3

amount of net working capital provided (or used) in business operations. Exhibit 3.2 summarises
the format of such a procedure.
Funds from business operations can also be obtained from the statement of retained earnings.
In order to ascertain funds from business operations with the help of the statement of retained
earnings, the following procedures should be adopted:
(i) Balance of profit at the end of the year requires adjustment as explained in Exhibit 3.1.
(ii) We should add back the amount of transfer to the general reserve or any other reserve
indicating appropriation out of profits as these transactions merely involve the reclassification
of items and do not involve any corresponding use of working capital.
(iii) Payment of dividends (as is separately shown under uses of the statement) should be added
back.
(iv) Finally, we should deduct the balance of profit at the beginning of the year.
The computation of funds from business operations is shown in Example 3.1.
Example 3.1
From the following income statement (Table 3.1) of ABC & Co., determine the funds obtained from
operations, by various methods.
Table 3.1 Income Statement of ABC & Co. for the Current Year

Amount (Rs)

Amount (Rs)

Sales revenues

Less: Cost of goods sold
2,00,000

Operating cash expenses
40,000

Depreciation
30,000

Amortisation of:
(i) Patent
5,000

(ii) Preliminary expenses
2,000

Loss on sale of old equipment
3,000

Operating income
Less: Income taxes

Add: Other income:

Gain on sale of land
5,000

Gain on redemption of debentures
1,000

Dividends from investments in other companies
4,000

Revaluation of land
15,000

Net income
Beginning balance of P & L A/c
Net Income for the current year


Less: Transfer to general reserve
15,000

Amortisation of goodwill
5,000

Dividend on preference shares
20,000

Dividend on equity shares
40,000

Ending balance of P & L A/c

4,20,000

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2,80,000
1,40,000
70,000
70,000

25,000
95,000
55,000
95,000
1,50,000

8,000
70,000

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4 Financial Management

Solution
Alternative 1: (based on Exhibit 3.2)


Sales revenues
Less: Expenses using working capital:

Cost of goods sold

Operating cash expenses

Income taxes

Funds from business operations

Amount (Rs)

4,20,000

Rs. 2,00,000
40,000
70,000

3,10,000
1,10,000

Alternative 2: (based on Exhibit 3.1)

Net Income
Add: Expenses not involving the use of working capital:

Depreciation
30,000

Amortisation
(i) Patent
5,000

(ii) Preliminary expenses
2,.000

Loss on sale of equipment
3,000

Less: Income not augmenting working capital:

Revaluation of land
15,000
Income separately reported:

Dividends from investment in other companies
4,000
Incomes clubbed with other items of sources and uses:

Gain from sale of land
5,000

Gain from redemption of debentures
1,000

Funds from business operations

95,000

40,000
1,35,000

25,000
1,10,000

Alternative 3: (Retained earnings account as base):

Ending balance of Profit and Loss A/c

Add: Expenses not involving the use of working capital:

Depreciation
30,000

Amortisation of
(i) Patent
5,000

(ii) Preliminary expenses
2,000

Goodwill
5,000

Loss on sale of equipment
3,000

Transfer to general reserve
15,000

Expenses separately reported:

Dividends on preference shares
20,000

Dividends on equity shares
40,000

Less: Incomes not augmenting working capital:

Revaluation of land
15,000
Income separately reported:

Dividends from investment in other companies
4,000

70,000

1,20,000
1,90,000

(Contd.)

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Fund Flow Statement 5

(Contd.)
Incomes clubbed with other items of sources and uses:

Gain from sale of land
5,000

Gain from redemption of debentures
1,000

Less: Beginning balance of P & L A/c

Funds from business operations

25,000
1,65,000
55,000
1,10,000

Changes in Non-Current Assets

Apart from funds from operations, the transactions relating to non-current assets also require some
special consideration. The changes in non-current assets like patents, goodwill and other intangible assets are due to their amortisations or acquisitions. If there is a decrease in their balances,
it is reasonable to assume, in the absence of information to the contrary, that the asset has been
amortised. An increase, on the other hand, implies purchase of an asset and accordingly should be
indicated as use of funds.
The changes in other non-current assets particularly plant and equipment account require a more
careful analysis to ascertain funds obtained from their sale or funds used in their acquisition.
For this purpose, we should investigate three things: (i) increase/decrease in plant and equipment
account and accumulated depreciation (if plant and equipment is maintained on gross basis), (ii)
gains or losses in the profit and loss account indicating that plants and equipment have been sold,
and (iii) other information relating to the acquisition and retirement of plant and equipment that
accompanies the financial statements. This is shown in Example 3.2.
Example 3.2
From the following information furnished to you relating to plant and equipment account of
Hypothetical Ltd., determine the funds obtained from sale of old plant and equipment:


Plant and equipment (gross)
Accumulated depreciation
Additional information:
(i) Loss on sale of plant and equipment
(ii) Depreciation charged during the year on plant and equipment
(iii) Purchase of new plant during the year

Previous year
Amount (Rs)

Current year
Amount (Rs)

1,00,000
20,000

1,25,000
30,000

1,000
14,000
35,000

Solution
The gross increase in plant and equipment is Rs 25,000. But the reported purchases are Rs 35,000.
From these two items of information, it follows that in absence of any sale on plant account, its
balance as at the end of the current year would have been Rs. 1,35,000 [Rs. 1,00,000 (opening
balance) + Rs. 35,000 (additions during the year)]. But the balance of the account is Rs. 1,25,000,
indicating that plant and equipment having a gross book value of Rs. 10,000 has been sold.
Further, we find that there is an increase in the balance of accumulated depreciation by Rs. 10,000
but the depreciation amount charged during the year is Rs. 14,000. Therefore, in the absence of
any writing-off the depreciation during the year, its balance would have been Rs. 34,000 [Rs. 20,000
(opening balance) + Rs. 14,000 (charged during the year)] as against Rs. 30,000 as at the end of

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6 Financial Management

current year. These facts, taken together, indicate that the amount of depreciation on the plant sold
is Rs.4,000.
We have, now, the following information relating to the plant and equipment that has been sold:


(Rs)

Gross book value (original purchase cost)

Accumulated depreciation
Net book value (Rs. 10,000 Rs. 4,000)
Therefore, sale proceeds of plant (Rs. 6,000 Rs. 1,000 loss)

10,000
4,000
6,000
5,000

The preceding information can be tabulated in the form of a ledger account which provides the
desired information more clearly.
Plant and equipment account

(Rs) 

(Rs)

Opening balance
1,00,000 Original cost of sold plant (balancing figure) 10,000
Cash (new equipment purchases given) 35,000 Closing balance
1,25,000

1,35,000 
1,35,000

Accumulated depreciation account

Total depreciation on sold plant Beginning balance
(balancing figure)
4,000
Closing balance
30,000 Depreciation expenses charged


during the year

34,000 

20,000
14,000
34,000

Changes in Non-Current Liabilities

Another item which deserves consideration in this connection is changes in non-current liabilities
(NCL). The analysis of changes in NCL account will be either due to a fresh issue of shares and
debentures or their redemption. The increase in the NCL account is indicative of an additional
issue of securities and is regarded as a source of funds. However, if it is due to the issue of bonus
shares, it is not a source of funds. It simply amounts to reclassification of accounts, i.e. reducing
retained earnings/reserves and increasing equity share capital. Otherwise, the net increase represents
the source of working capital. It should be checked whether the new issue of securities is at par,
premium or discount. In the case of the latter two situations, the net increase would not be the true
representative of the source of funds. In the case of premium, the actual amount received would
be more, while it would be less if the new issue is made at discount. Likewise, in the case of the
retirement of debt or preference shares care should be taken to ascertain whether the redemption is
at par, premium or discount. Example 3.3 illustrates on a comprehensive basis the SCFPworking
capital basis.
Example 3.3
Given below are the balance sheets as on December 31, previous year and current year and a
statement of income and reconciliation of earnings for the current year of Electronics Ltd. The only
item in the Buildings and Equipment account sold during the year was a specialised machine that
originally cost Rs. 15,000: The accumulated depreciation on this machine at the time of sale was Rs.
8,000. The machine was sold for Rs. 6,000 and full payment was received in cash. The Company

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Fund Flow Statement 7

purchased patents of Rs. 16,000 during the year. Besides cash purchases of plant and equipment
the assets of another company were also purchased for Rs. 1,00,000 payable in fully paid-up shares,
issued at par; assets purchased were, goodwill Rs. 30,000 and equipments Rs. 70,000.
Omparative balance sheets

December 31
Previous
Year (Rs)

Cash
Accounts receivable
Inventories
Pre-paid expenses
Land
Patents
Buildings and equipment
Less: Accumulated depreciation
Goodwill
Total assets
Accounts payable
Notes payable
Estimated income-tax
Social security taxes accrued
Debentures
Equity capital
Retained earnings
Total Liabilities

74,000
54,000
3,12,000
6,000
60,000
55,000
4,20,000
(1,05,000)

8,76,000
58,000
28,000
86,000
3,000
2,20,000
2,50,000
2,31,000
8,76,000

December 31
Current
Year (Rs)
37,000
47,000
2,77,000
4,000
60,000
65,000
5,50,000
(1,20,000)
30,000
9,50,000
94,000
8,000
12,000
5,000
60,000
5,60,000
2,11,000
9,50,000

Statement of income and reconciliation of earnings for current year

Net sales
Less cost of goods sold
Gross profit

Less operating expenses
(includes depreciation on buildings and equipment)

Less Interest on debentures

Net loss from operations
Less other revenues

Net loss
Add retained earnings (previous year)

Less dividend paid
Rs. 16,000
Less loss on sale of assets
1,000
Retained earnings (December 31, current year)

Amount (Rs)
19,70,000
14,80,000
4,90,000
4,86,000
14,000
(10,000)
7,000
(3,000)
2,31,000
2,28,000
17,000
2,11,000

From the foregoing information, prepare a funds-flow statement for Electronics Ltd.

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8 Financial Management

Solution
Table 3.2 Funds Statement of Electronics Limited for the Current Year
(A) Sources of funds:


Funds from business operations:

Net sales
19,70,000

Less: Cost of goods sold
Rs. 14,80,000

Less: Cash operating expenses
4,57,000

Less: Interest
14,000


Funds from other revenues


Sale of non-current assets (machine)


Issue of long-term liabilities for cash (equity capital)


(B) Uses of funds:

Purchase of non-current assets:

Buildings and equipment (cash)


Patents

Payment of long-term liabilities (debentures)


Recurring payments to investors:

Dividend paid to share-holders



Net decrease in working capital (B A) (uses-sources)

Amouint (Rs)

19,000
7,000
6,000
2,10,000
2,42,000

(7.8)
(2.9)
(2.5)
(86.8)
(100.0)

75,000
16,000
1,60,000

(31.0)
(6.6)
(66.1)

16,000
2,67,000
25,000

(6.6)
(110.3)
(10.3)

Note: Figures in brackets are percentages to the sources

Building and equipment account
To balance b/d
To equity share capital
To cash (purchases)



Rs 4,20,000
70,000
75,000

By
By
By
By

cash
P&L A/c
accumulated depreciation
balance c/d

5,65,000 

Rs 6,000
1,000
8,000
5,50,000
5,65,000

Patent account
To balance b/d
To cash (purchases)

55,000 By P & L A/c (amortisation)

16,000
By balance c/d
71,000 

6,000
65,000
71,000

Interpretation
Example 3.3 highlights clearly the financing and investing activities of Electronics Ltd. The companys
major source of funds is the issue of additional equity capital (86.8%). Funds from other sources
constitute a minor part (13.2%) of its total financial resources mobilised. On the uses side, the major
items are payment of long-term liabilities (66.1%) and purchases of buildings and equipment (31%).
In absolute terms, the funds obtained by issue of equity shares in the market (Rupees 2,10,000)
have been utilised primarily for repayment of debentures (Rs. 1,60,000) and partly for the purchase
of building and equipment (Rs. 75,000).
It reflects shortage of working capital with the firm. There has been a decrease in every component
of current assets (Table 3.2). The firm is required to raise additional long-term funds to salvage

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Fund Flow Statement 9

its current financial position. The above illustration clearly shows the immense usefulness of the
statement of changes in financial position to know major activities of the firm: financial, operational
and investment.
Table 3.3 Statement of Changes in Working Capital

December 31, December 31, Working Capital

Previous year Current year
Increase Decrease

(+ Rs)
( Rs)
(A) Current assets:

Cash

Accounts receivable

Inventories

Pre-paid expenses

(B) Current liabilities:

Accounts payable

Notes payable

Estimated income tax

Social security tax


Net working capital: (CA CL)

Decrease in net working capital

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74,000
54,000
3,12,000
6,000
4,46,000

37,000
47,000

2,77,000

4,000
3,65,000

37,000
7,000
35,000
2,000

58,000
28,000
86,000
3,000
1,75,000

94,000

8,000
20,000
12,000
74,000
5,000
1,19,000

36,000

2,71,000

2,71,000

2,46,000
25,000
2,71,000

94,000
25,000
1,19,000

2,000
*
1,19,000
*
1,19,000

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