FUNDS & CASH FLOW ANALYSIS

Funds are defined as that part of current assets which are financed through long term liabilities. The formula to compute Funds is as below: Funds (Net Working Capital) = Current Assets Current Liabilities The net change in funds over a period of tile indicates the changes in liquidity position of the company. A sound company will have positive funds from operations which may be used for expansion of the business. In funds flow analysis the first step is to ascertain net changes in funds (working capital) over a period of time by preparing Schedule of changes in working capital. The second step is to analyse the sources and uses of funds which will help us in correct assessment of the liquidity position. Schedule of changes in working capital is prepared by taking the amounts of current assets and current liabilities (opening or in the beginning and closing or at the end of the year) from the Balance Sheet. The format of the statement is given below: Schedule of Changes in Working Capital Particulars Current Assets (When Increase over the period) Current Assets (When Decrease over the period) Current Liabilities (When Increase over the period) Current Liabilities (When Decrease over the period) Net Increase in Funds OR Net Decrease in Funds Total Amount (Beginning) CA0 CA1 CL0 CL1 Amount (Closing) CA1 CA0 CL1 CL0 Changes in Working Capital Increases Decreases CA1 CA0 (Increases in currents assets) CA0 CA1 (Decreases in Current Assets) CL0 CL1 (Decreases in Current Liabilities) CL1 CL0 (Increases in currents Liabilities) Balancing Figure is written here Balancing Figure is written here TOTAL AMOUNT TOTAL AMOUNT

This statement tells us about the net change in funds over the period, but how this change has taken place is not reveled. We need to know from what sources the funds were generated and where these have been used. For this purpose we need to prepare Statement of Sources and Applications of Funds or also called Funds Flow Statement The procedure to prepare the statement is given below: The business transactions affect the assets, liabilities and equity of the company. We need to identify those transactions which will affect funds. The test to find out this is very simple. The funds are computed by subtracting current liabilities from current assets. Therefore, we will analyse the transactions by looking at how these affect current assets and current liabilities to ascertain their effect on funds. The analysis of the transactions is interpreted as below: Transactions not affecting Funds:

i) If a transaction does not affect any current asset or current liability, it does not affect funds. ii) if a transaction affects only current assets (one current asset increases and another current asset decrease by the same amount) or only current liabilities (one current liability increases and another current liability decrease by the same amount), then such transaction does not affect funds. iii) When a transaction affects current assets and current liabilities simultaneously increasing or decreasing both by the same amount, then such a transaction will not affect funds. Transactions affecting Funds: i) If a transaction affects Current assets and current liabilities by different amounts, and for the balancing figure some other account (fixed asset, fixed liability or equity) are affected, then such transaction will affect the funds. The funds will change by the difference in amount affecting current assets and current liabilities. If current assets have increased by more amount than the increase in current liabilities or decreased by lesser amount than the decrease in current liabilities, it will increase funds and is called Source of Funds. On the other hand, if current assets have decreased by more amount than decrease in current liabilities or increased by lesser amount than the increase in current liabilities, it will decrease funds and is called Use of Funds. ii) If a transaction affects the current assets on the one hand and fixed assets, fixed liabilities or equity on the other hand, then such transaction will affect funds. If the current assets have increased, it will increase the funds, and is called Source of Funds. iii) If a transaction affects the current assets on the one hand and fixed assets, fixed liabilities or equity on the other hand, then such transaction will affect funds. If the current assets have decreased, it will decrease the funds, and is called Use of funds. iv) If a transaction affects the current liabilities on the one hand and fixed assets, fixed liabilities or equity on the other hand, then such transaction will affect funds. If the current liabilities have decreased, it will increase the funds, and is called Source of funds. v) If a transaction affects the current liabilities on the one hand and fixed assets, fixed liabilities or equity on the other hand, then such transaction will affect funds. If the current liabilities have increase, it will decrease the funds, and is called Use of funds. We do not have the detailed information about the transactions, and therefore it is not possible to find out the sources and uses of funds directly from the transactions. We are given the financial statements (Income statement or P & L A/c and Balance Sheet) and some additional information. We can use this to find out sources and uses of funds. This is called indirect method of finding sources and uses of funds. Sources of Funds: i) Funds from Operations The operations of the business result in getting revenues and incurring expenses, the net difference between the two is called net income or profit. The profit is ascertained by subtracting certain expenses which do not result in decrease in current asset or increase in current liabilities. Such items, though, will decrease the profits but not the funds. Therefore, we need to make some adjustments to the net profit to ascertain Funds from Operations. Similarly, gains will increase the profit but they are taken as source else where, therefore need to be eliminated from Funds from Operations, and therefore, need to be subtracted from the net income or profit. The Funds from Operations are computed as below: Statement of Computation of Funds from Operations

Particulars Net Profit for the Year: Add: Depreciation Charged Loss on sale of Fixed Assets Loss on sale of Investments Misc. Expenses written off Fixed assets written off Provision for Tax Gain on Sale of Fixed Assets Dividends Received Funds from Operations

Amount xxx

Amount xxx xxx xxx xxx xxx xxx

xxx xxx

(xxx) xxx

CASH FLOW ANALYSIS: Funds flow analysis suffers from the major limitation that the liquidity is not fully reflected by this analysis. The quality of current assets will make the difference, thus, a firm reporting positive change in funds may still have problems as the current assets are of poor quality. Cash flow analysis is superior to Funds flow analysis. Also, the cash flows are divided into three major categories, viz. Operating, investing and financing activities, to have a better understanding of the liquidity position of the company. Meaning: Cash flow statement indicates the sources and uses of cash flows. The transactions resulting in cash in-flows are called sources of cash flows; and those transactions that result in cash out-flows are called uses of cash flows. The information contained in cash flow statement is more reliable as cash flows are not affected by subjective judgment, estimates and accounting policies. Cash for the purpose of cash flow includes cash and cash equivalents. Cash consists of cash in hand and cash at bank. Cash equivalents are short term highly liquid investments that are readily convertible into known amount of changes in value. These are having short term maturity period usually not more than three months. The sources and uses of cash are given below: Sources of cash (Cash in-flows) 1. Business operations/operating activities 2. Sale of Fixed Assets 3. Issue of Equity & Pref. Shares 4. Issue of Debentures 5. Long Term Loans raised 6. Interest received in Investments 7. Dividends received in Investment 8. Other Items (Specify) Uses of Cash (Cash out-flows) 1. Purchase of Fixed Assets 2. Purchase of Investments 3. Redemption of Pref. Shares & Debentures 4. Repurchase of Equity Shares 5. Repayment of Loans 6. Payment of Interest 7. Payment of Dividend on Pref. & Eq. Capital 8. Other Items (Specify)

The cash flows computed are divided into three categories viz. operating; investing and financing activities. The separate disclosure under these categories helps us to make proper analysis and have better understanding of the liquidity position of the firm. The computation of cash flows under each category is discussed below: Cash flows from operating activities: The cash flow accruing from main operating activities (also called as revenue producing activities like sale of goods and services) are called cash flows from operating activities. The net cash flow from operating activities represent the net cash received from main operations of the business. The sources of cash or cash in-flows from operating activities are: i) cash receipts from sale of goods and rendering of services; ii) cash receipts from royalties, fees, commissions, and other revenues; and

iii) refunds of income taxes unless they can be specifically identified with financing and investing activities. The sources (cash in-flows) and uses of cash (cash out-flows) from operating activities are: i) ii) iii) Sources of Cash (Cash in-flows) Cash receipts from sale of goods and rendering of services; Cash receipts from royalties, fees, commissions, and other revenues; and Refunds of income taxes unless they can be specifically identified with financing and investing activities. i) ii) iii) iv) Uses of Cash (Cash out-flows) cash payment to suppliers for goods and services; Cash payment to employees; cash payments for other expenses related to production, establishment and marketing; Cash payments of income taxes unless they can be specifically identified with financing and investing activities.

Cash flows from investing activities: The cash flows accruing from acquisition and disposal of fixed assets and investments (not included in cash equivalents) are called cash flows from investing activities. Given below are the sources and uses of cash from investing activities: i) ii) iii) iv) Sources of Cash (Cash in-flows) Cash receipts from disposal of fixed assets Cash receipts from sale of investments Cash receipts towards interest & dividends Cash receipts from repayment of loans and advances Uses of Cash (Cash out-flows) i) Cash paid for purchase of fixed assets ii) Cash paid for purchase of investment iii) Cash advances and loans made to 3rd parties

Cash flows from financing activities: The cash flows from financing the firm and repaying debts as well as distribution to owners and payment of interest are called cash flows from financing activities. i) ii) iii) iv) Sources of Cash (Cash in-flows) Cash receipts from issue of Equity shares Cash receipts from issue of Pref. shares Cash receipts from issue of debentures Cash receipts from long term loans raised i) ii) iii) iv) v) Uses of Cash (Cash out-flows) Buy-back of shares Redemption of Preference shares Redemption of debentures Repayment of long term loans Payment of interest and dividends

Q1. Selected financial information of a company is given below: Current Assets: July 1, 2007 June 30, 2008 Stock Rs. 850,000 Rs. 900,000 Debtors 500,000 600,000 Accrued Revenues 60,000 40,000 Prepaid Expenses 18,000 20,000 Bills Receivable 22,000 18,000 Cash in Hand & at Bank 34,000 59,000 Current Liabilities: Sundry Creditors 560,000 440,000 Bills Payable 18,000 20,000 Revenues Received in Advance 42,000 56,000 Other Information: Net income for the year was Rs. 2,750,000 after charging depreciation and interest of Rs. 580,000 and Rs. 350,000 respectively. There was a loss of Rs. 52,000 on sale of old

furniture. In the current year deferred revenue expenses of Rs. 30,000 were written off. Ascertain cash flow from operating activities for the year. Solution: Cash Flows from Operating Activities: Net Income Add: Depreciation Loss on sale of old furniture Interest paid on Debentures Def. Rev. Expenses written off Decrease in Accrued Revenues Decrease in Bills Receivables Increase in Bills payable Increase in Revenues Received in Advance Less: Increase in stock Increase in Debtors Increase in Prepaid Expenses Decrease in Sundry Creditors Net Cash In-flow from operating activities Rs. Rs. 2,750,000 580,000 52,000 350,000 30,000 20,000 4,000 2,000 14,000 50,000 100,000 2,000 120,000

(272,000) 3,530,000

Q2. Prepare Cash Flow Statement from the Balance Sheets and other information given related to Marie Industries Ltd. Balance Sheet of National Industries Ltd. as at June 30, 2008 (Rupees in thousands) Particulars Amount Amount Particulars Amount Amount Equity Capital 600 700 Land 360 360 Reserves 170 200 Buildings 500 532 P & L App. A/c 140 210 Furniture 50 60 Debentures 150 100 Motor Vehicles 40 52 Sundry Creditors 96 124 Stock 78 96 Bills payable 24 26 Sundry Debtors 112 150 Outstanding 32 20 Cash & Bank 72 130 Expenses ______ ______ ______ ______ TOTAL 1212 1380 TOTAL 1212 1380 _______ ______ ______ _______ Net Income after interest and tax but before dividends was Rs. 160 thousands. Depreciation charged on: Buildings Rs. 10,000, Furniture Rs. 4,000 and Motor Vehicles Rs. 8,000. No fixed assets were sold during the year. Interest paid during the year was 18,000, dividends 60,000 and tax paid was 40,000 Q3. Selected financial information of a company is given below: Current Assets: July 1, 2007 Stock Rs. 850,000 Debtors 500,000 Accrued Revenues 60,000 Prepaid Expenses 18,000 Bills Receivable 22,000 Cash in Hand & at Bank 34,000 Current Liabilities: Sundry Creditors 560,000

June 30, 2008 Rs. 900,000 600,000 40,000 20,000 18,000 59,000 440,000

Bills Payable Revenues Received in Advance

18,000 42,000

20,000 56,000

Other Information: Net income for the year was Rs. 2,750,000 after charging depreciation of Rs. 580,000. There was a loss of Rs. 52,000 on sale of old furniture, interest paid on debentures Rs. 350,000. In the current year deferred revenue expenses of Rs. 30,000 were written off. Ascertain cash flow from operating activities for the year.

Funds are defined as that part of current assets which are financed through long term liabilities. The formula to compute Funds is as below: Funds (Net Working Capital) = Current Assets Current Liabilities The net change in funds over a period of tile indicates the changes in liquidity position of the company. A sound company will have positive funds from operations which may be used for expansion of the business. In funds flow analysis the first step is to ascertain net changes in funds (working capital) over a period of time by preparing Schedule of changes in working capital. The second step is to analyse the sources and uses of funds which will help us in correct assessment of the liquidity position. Schedule of changes in working capital is prepared by taking the amounts of current assets and current liabilities (opening or in the beginning and closing or at the end of the year) from the Balance Sheet. The format of the statement is given below: Schedule of Changes in Working Capital Particulars Current Assets (When Increase over the period) Current Assets (When Decrease over the period) Current Liabilities (When Increase over the period) Current Liabilities (When Decrease over the period) Net Increase in Funds OR Net Decrease in Funds Total Amount (Beginning) CA0 CA1 CL0 CL1 Amount (Closing) CA1 CA0 CL1 CL0 Changes in Working Capital Increases Decreases CA1 CA0 (Increases in currents assets) CA0 CA1 (Decreases in Current Assets) CL0 CL1 (Decreases in Current Liabilities) CL1 CL0 (Increases in currents Liabilities) Balancing Figure is written here Balancing Figure is written here TOTAL AMOUNT TOTAL AMOUNT

This statement tells us about the net change in funds over the period, but how this change has taken place is not reveled. We need to know from what sources the funds were generated and where these have been used. For this purpose we need to prepare Statement of Sources and Applications of Funds or also called Funds Flow Statement The procedure to prepare the statement is given below: The business transactions affect the assets, liabilities and equity of the company. We need to identify those transactions which will affect funds. The test to find out this is very simple. The funds are computed by subtracting current liabilities from current assets. Therefore, we will analyse the transactions by looking at how these affect current assets and current liabilities to ascertain their effect on funds. The analysis of the transactions is interpreted as below: Transactions not affecting Funds: i) If a transaction does not affect any current asset or current liability, it does not affect funds. ii) if a transaction affects only current assets (one current asset increases and another current asset decrease by the same amount) or only current liabilities (one current liability increases and another current liability decrease by the same amount), then such transaction does not affect funds. iii) When a transaction affects current assets and current liabilities simultaneously increasing or decreasing both by the same amount, then such a transaction will not affect funds. Transactions affecting Funds: i) If a transaction affects Current assets and current liabilities by different amounts, and for the balancing figure some other account (fixed asset, fixed liability or equity) are affected, then such transaction will affect the funds. The funds will change by the difference in amount affecting current assets and current liabilities. If current assets have increased by more amount than the increase in current liabilities or decreased by lesser amount than the decrease in current liabilities, it will increase funds and is called Source of Funds. On the other hand, if current assets have decreased by more amount than decrease in current liabilities or increased by lesser amount than the increase in current liabilities, it will decrease funds and is called Use of Funds. ii) If a transaction affects the current assets on the one hand and fixed assets, fixed liabilities or equity on the other hand, then such transaction will affect funds. If the current assets have increased, it will increase the funds, and is called Source of Funds. iii) If a transaction affects the current assets on the one hand and fixed assets, fixed liabilities or equity on the other hand, then such transaction will affect funds. If the current assets have decreased, it will decrease the funds, and is called Use of funds. iv) If a transaction affects the current liabilities on the one hand and fixed assets, fixed liabilities or equity on the other hand, then such transaction will affect funds. If the current liabilities have decreased, it will increase the funds, and is called Source of funds. v) If a transaction affects the current liabilities on the one hand and fixed assets, fixed liabilities or equity on the other hand, then such transaction will affect funds. If the current liabilities have increase, it will decrease the funds, and is called Use of funds. We do not have the detailed information about the transactions, and therefore it is not possible to find out the sources and uses of funds directly from the transactions. We are given the financial statements (Income statement or P & L A/c and Balance Sheet) and some additional information. We can use this to find out sources and uses of funds. This is called indirect method of finding sources and uses of funds.

Sources of Funds: i) Funds from Operations The operations of the business result in getting revenues and incurring expenses, the net difference between the two is called net income or profit. The profit is ascertained by subtracting certain expenses which do not result in decrease in current asset or increase in current liabilities. Such items, though, will decrease the profits but not the funds. Therefore, we need to make some adjustments to the net profit to ascertain Funds from Operations. Similarly, gains will increase the profit but they are taken as source else where, therefore need to be eliminated from Funds from Operations, and therefore, need to be subtracted from the net income or profit. The Funds from Operations are computed as below: Particulars Net Profit for the Year: Add: Depreciation Charged Loss on sale of Fixed Assets Loss on sale of Investments Misc. Expenses written off Fixed assets written off Provision for Tax Gain on Sale of Fixed Assets Dividends Received Amount xxx xxx xxx xxx xxx xxx xxx xxx ____ (xxx) _______ xxx _______ Format of Funds Flow Statement Uses of Funds Amount Particulars XXX Purchase of Fixed Assets XXX Purchase of Long Term Investments XXX Dividends Paid XXX Buy Back of Equity Shares XXX Redemption of Pref. Shares XXX Redemption of Debentures Long Term Loans Repaid Payment of Income Tax XXX* Net Increase in Funds XXX Total Amount xxx

Funds from Operations

Sources of Funds Particulars Funds from Operations Sale of Fixed Assets Sale of Long Term Investments Issue of Shares Issue of Debentures Long Term Loans Raised Net Decrease in Funds Total

Amount XXX XXX XXX XXX XXX XXX XXX XXX XXX* XXX

*This represents the balancing figure and will appear either on left side (decrease in funds) or on right side (increase in funds).

CASH FLOW ANALYSIS: Funds flow analysis suffers from the major limitation that the liquidity is not fully reflected by this analysis. The quality of current assets will make the difference, thus, a firm reporting positive change in funds may still have problems as the current assets are of poor quality. Cash flow analysis is superior to Funds flow analysis. Also, the cash flows are divided into three major

categories, viz. Operating, investing and financing activities, to have a better understanding of the liquidity position of the company. Meaning: Cash flow statement indicates the sources and uses of cash flows. The transactions resulting in cash in-flows are called sources of cash flows; and those transactions that result in cash out-flows are called uses of cash flows. The information contained in cash flow statement is more reliable as cash flows are not affected by subjective judgment, estimates and accounting policies. Cash for the purpose of cash flow includes cash and cash equivalents. Cash consists of cash in hand and cash at bank. Cash equivalents are short term highly liquid investments that are readily convertible into known amount of changes in value. These are having short term maturity period usually not more than three months. The sources and uses of cash are given below: Sources of cash (Cash in-flows) 1. Business operations/operating activities 2. Sale of Fixed Assets 3. Issue of Equity & Pref. Shares 4. Issue of Debentures 5. Long Term Loans raised 6. Interest received in Investments 7. Dividends received in Investment 8. Other Items (Specify) Uses of Cash (Cash out-flows) 1. Purchase of Fixed Assets 2. Purchase of Investments 3. Redemption of Pref. Shares & Debentures 4. Repurchase of Equity Shares 5. Repayment of Loans 6. Payment of Interest 7. Payment of Dividend on Pref. & Eq. Capital 8. Other Items (Specify)

The cash flows computed are divided into three categories. The computation of cash flows under each category is discussed below: Cash flows from operating activities: The cash flow accruing from main operating activities (also called as revenue producing activities like sale of goods and services) are called cash flows from operating activities. The sources of cash or cash in-flows from operating activities are: i) cash receipts from sale of goods and rendering of services; ii) cash receipts from royalties, fees, commissions, and other revenues; and iii) refunds of income taxes unless they can be specifically identified with financing and investing activities. The uses of cash or cash out-flows from operating activities are i) cash payment to suppliers for goods and services; ii) cash payment to employees; iii) cash payments for other expenses related to production, establishment and marketing, iv) cash payments of income taxes unless they can be specifically identified with financing and investing activities. Cash flows from investing activities: The cash flows accruing from acquisition and disposal of fixed assets and investments (not included in cash equivalents). Given below are the sources and uses of cash from investing activities: Sources of cash (Cash in-flows) Uses of Cash (Cash out-flows) 1. Cash receipts from disposal of fixed assets 1. Cash paid for purchase of fixed assets 2. Cash receipts from sale of investments 2. Cash paid for purchase of investment 3. Cash receipts towards interest & dividends 3. Cash advances and loans made to 3rd parties 4. Cash receipts from repayment of loans and advances Cash flows from financing activities: The cash flows from financing the firm and repaying debts as well as distribution to owners and payment of interest are called cash flows from financing activities. Sources of Cash (Cash in-flows) Uses of Cash (Cash out-flows)

v) vi) vii) viii)

Cash receipts from issue of Equity shares Cash receipts from issue of Pref. shares Cash receipts from issue of debentures Cash receipts from long term loans raised

vi) Buy-back of shares vii) Redemption of Preference shares viii) Redemption of debentures ix) Repayment of long term loans x) Payment of interest and dividends

Q1. Selected financial information of a company is given below: Current Assets: July 1, 2007 June 30, 2008 Stock Rs. 850,000 Rs. 900,000 Debtors 500,000 600,000 Accrued Revenues 60,000 40,000 Prepaid Expenses 18,000 20,000 Bills Receivable 22,000 18,000 Cash in Hand & at Bank 34,000 59,000 Current Liabilities: Sundry Creditors 560,000 440,000 Bills Payable 18,000 20,000 Revenues Received in Advance 42,000 56,000 Other Information: Net income for the year was Rs. 2,750,000 after charging depreciation and interest of Rs. 580,000 and Rs. 350,000 respectively. There was a loss of Rs. 52,000 on sale of old furniture. In the current year deferred revenue expenses of Rs. 30,000 were written off. Ascertain cash flow from operating activities for the year. Solution: Cash Flows from Operating Activities: Net Income Add: Depreciation Loss on sale of old furniture Interest paid on Debentures Def. Rev. Expenses written off Decrease in Accrued Revenues Decrease in Bills Receivables Increase in Bills payable Increase in Revenues Received in Advance Less: Increase in stock Increase in Debtors Increase in Prepaid Expenses Decrease in Sundry Creditors Net Cash In-flow from operating activities Rs. Rs. 2,750,000 580,000 52,000 350,000 30,000 20,000 4,000 2,000 14,000 50,000 100,000 2,000 120,000

(272,000) 3,530,000

Q2. Prepare Cash Flow Statement from the Balance Sheets and other information given related to Marie Industries Ltd. Balance Sheet of National Industries Ltd. as at June 30, 2008 (Rupees in thousands) Particulars Amount Amount Particulars Amount Amount Equity Capital 600 700 Land 360 360 Reserves 170 200 Buildings 500 532 P & L App. A/c 140 210 Furniture 50 60 Debentures 150 100 Motor Vehicles 40 52

Sundry Creditors 96 124 Stock 78 96 Bills payable 24 26 Sundry Debtors 112 150 Outstanding 32 20 Cash & Bank 72 130 Expenses ______ ______ ______ ______ TOTAL 1212 1380 TOTAL 1212 1380 _______ ______ ______ _______ Net Income after interest and tax but before dividends was Rs. 160 thousands. Depreciation charged on: Buildings Rs. 10,000, Furniture Rs. 4,000 and Motor Vehicles Rs. 8,000. No fixed assets were sold during the year. Interest paid during the year was 18,000, dividends 60,000 and tax paid was 40,000. Solution: CASH FLOW STATEMENT Cash Flows from Operating Activities: Rs. in 000s Rs. in 000s Net Income 160.00 Add Depreciati0n on: Buildings 10.00 Furniture 4.00 Motor Vehicles 8.00 Interest paid on Debentures 18.00 Income Tax Paid 40.00 Increase in S. Creditors 28.00 Increase in Bills payable 2.00 Less: Increase in stock 18.00 Increase in Debtors 38.00 Decrease in Outstanding Expenses 12.00 - 68.00 Net Cash In-flow from operating activities 202.00 Less Tax paid - 40.00 Cash In-flow from Operating Activities 162.00 Cash Flow from Investing Activities: Cash Out-flows from: Additions to Buildings Purchase of Furniture Purchase of Motor Vehicles Net Cash Out-flows from Investing Activities Cash Flows from Financing Activities: Cash In-flow from Issue of Equity Shares Cash Out-flows from: Redemption of Debentures Payment of Interest Payment of Dividends Net Cash Out-flow from Financing Activities Net Increase in Cash Balance over the period Opening Cash Balance Closing Cash Balance

- 42.00 - 14.00 - 20.00 - 76.00 100.00 - 50.00 - 18.00 - 60.00 - 28.00 58.00 72.00 130.00