Dibrugarh University B.COM 5TH SEMESTER MANAGEMENT ACCOUNTING NOTES UNIT -2

 


CASH FLOW STATEMENT AND FUND FLOW STATEMENT


UNIT – II


Q1. What is Cash Flow Statement? What are its objectives?

Ans: Cash flow statement is a statement which describes the inflows and outflows of cash and cash equivalents in an enterprise during a specified period of time. A cash flow statement summarises the causes of changes in cash position of a business enterprise between dates of two balance sheets. According to AS-3 (Revised), an enterprise should prepare a cash flow statement and should present it for each period for which financial statements are prepared.

Following are the objectives of Cash Flow Statements:

a. To recognise the sources from operation, investing and financing activities from where cash and cash equivalent are generated.

b. To recognises the uses by operating, investing and financing activities for which cash and cash equivalents were used by the enterprise.

c. To compute the net changes in cash and cash equivalents indicating the difference between sources and uses from operating, investing and financing activities between the dates of two balance sheets.

Q2. What are the uses and significance of cash flow statement?

Ans:- Following are the uses and significance of cash flow statement:

1. Cash flow statement is based on the cash basis of accounting; it is very useful in the evaluation of cash position of a firm.

2. Cash flow statement is prepared in order to know the future cash position of a concern so as to enable a firm to plan and coordinate its financial operations properly.

3. Cash flow statement helps in planning the repayment of loans, replacement of fixed assets and other similar long term planning of cash.

4. Cash flow statement provides information of all activities classified under operating, investing and financing activities.

5. Cash flow statement is prepared according to AS-3 (Revised) is more suitable for making comparisons than the funds flow statement as there is no standard format used for the same.

6. A series of intra-firm and inter-firm cash flow statements reveals whether the firm’s liquidity is improving or deteriorating over a period of time and in comparison to other firms over a period of time.

7. Cash flow statements provide information of all activities classified under operating, investing and financing activities. The fund flow statement even when prepared on cash basis, did not disclose cash flows from such activities separately, thus, cash flow statement is more useful than the funds flow statements.

Q3. What are the limitations of Cash flow statement?

Ans: - Following are the limitations of Cash flow statement:

1. Cash flow statement is based on cash basis of accounting; it ignores the basic accounting concept of accrual basis.

2. Cash flow statement is not suitable for judging the profitability of a firm as non-cash charges are ignored while calculating cash flows from operating activities.

3. Cash flow statement is not a substitute of an income statement; it is complementary to an income statement. Net cash flow does not mean the net income of a firm.

4. Cash flow statement is also not a substitute of funds flow statement which provides information relating to the causes that lead to increase or decrease in working capital.

5. A comparative study of cash flow statements may give misleading results.

6. Some people feel that as working capital is a wider concept of funds, a funds flow statement provides a more complete picture than cash flow statement.


Q4. State the procedure for preparing a cash flow statement. Or How cash flow statement is prepared?

Ans: Cash flow statement is not a substitute of income statement, i.e., a profit and loss account, and a balance sheet. It provides additional information and explains the reasons for changes in cash and cash equivalents, derived from financial statements at two points of time. The procedure for preparing a cash flow statement is different from the procedure followed in respect of profit and loss account and balance sheet. It is prepared with the help of financial statements. The basic information required for the preparation of a cash flow statement is obtained from the following three sources:

(i) Comparative balance sheets at two points of time, i.e. in the beginning and at the end of the accounting period.

(ii) Income statement of the current accounting period or the profit and loss account.

(iii) Some selected additional data to extract the hidden transactions.

The preparation of a cash flow statement involves the following steps:

1. Compute the net increase or decrease in cash and cash equivalents, by making a comparison of these accounts given in the comparative balance sheets.

2. Calculate the net cash flow provided (used in) operating activities: Operating activities are the principal revenue producing activities of the enterprise. The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise pay dividends, repay loans, and make new investments without recourse to external sources of financing. There are two methods of reporting cash flows from operating activities: the direct method and the indirect method.

3. Calculate the net cash flow from (used in) investing activities: Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources intended to generate future income and cash flows.

4. Calculate the net cash flow from (used in) financing activities: Financing activities are activities that result in changes in the size and composition of the owner’s capital and borrowings of the enterprise. Cash flows arising from financing activities are important because it is useful in predicting claims on future cash flows by providers of funds to the enterprise.

5. Prepare a formal cash flow statement highlighting the net cash flow from (used in) operating, investing and financing activities separately.

6. Make an aggregate of net cash flows from the three activities and ensure that the total net cash flow is equal to the net increase or decrease in cash and cash equivalents as calculated in step one.

Q5. What are the differences between Fund Flow Statement and Cash Flow Statement?

Ans: Following are the differences between Fund Flow Statement and Cash Flow Statement:

Basis of difference

Fund Flow Statement

Cash Flow Statement

1. Basis of concept

It is based on a wider concept of funds, i. e., working capital.

It is based on a narrower concept of funds , i.e., cash.

2. Basis of accounting

It is based on accrual basis of accounting.

It is based on cash basis of accounting.

3. Schedule of changes in working capital

Schedule of changes in working capital is prepared to show the changes in current assets and current liabilities.

No such schedule of changes in working capital is prepared.

4. Method of preparing

Fund Flow Statement reveals the sources and application of funds. The net difference between sources and applications of funds represents net increase or decrease in working capital.

It is prepared by classifying all cash inflows and outflows in terms of operating, investing and financing activities. The net difference represents the net increase or decrease in cash and cash equivalents.

5. Basis of usefulness

It is useful in planning intermediate and long term financing.

It is more useful for short-term analysis and cash planning of the business.

6. Basis of Improvement

Improvement in funds position of a firm does not necessarily lead to improvement in cash position.

Improvement in cash position results in improvement of funds position of the firm.

7. Cash and cash equivalent

The opening and closing balances of cash are included in the schedule of changes in working capital.

The balances of cash and cash equivalents at the beginning and at the end of the period are shown in the cash flow statement.

 

Q6. What is Funds Flow Statement?

Ans: Funds Flow Statement is a method by which we study changes in the financial position of a business enterprise between beginning and ending financial statements dates. It is a statement showing sources and uses of funds for a period of time.

   According to Foulke defines Funds Flow Statement as, “A statement of sources and application of funds is a technical device designed to analyse the changes in the financial condition of a business enterprise between two dates.”


Q7. What are the uses, significance and importance of Funds Flow Statement?

Ans: A Funds Flow Statement is an essential tool for the financial analysis and is of primary importance to the financial management. Now-a-days, it is being widely used by the financial analysis, credit granting institutions and financial managers. The basic purpose of a fund flow statement is to reveal the changes in the working capital on the two balance sheet dates. It also describes the sources from which additional working capital has been financed and the uses to which working capital has been applied.

Following are the uses, significance and importance of Funds Flow Statement:

1. It helps in the analysis of financial operations: The financial statements reveal the net effect of various transactions on the operational and financial position of a concern. The balance sheet gives a static view of the resources of a business and the use to which these resources have been put at a certain point of time.

2. It helps in the formation of a realistic dividend policy: Sometimes a firm has sufficient profits available for distribution as dividend but yet it may not be advisable to distribute dividend for lack of liquid or cash resources. In such a cases, a funds flow statement helps in the formation of a realistic dividend policy.

3. It helps in the proper allocation of resources: The resources of a concern are always limited and it wants to make the best use of these resources. A projected funds flow statement constructed for the future helps in making managerial decisions.

4. It acts as a future guide: A projected fund flow statement also acts as a guide for future to the management. The management can come to know the various problems it is going to face in near future for want of funds. The firm can arrange to finance these needs more effectively and avoid future problems.

5. It helps in appraising the use of working capital: A funds flow statement helps in explaining how efficiently the management has used its working capital and also suggests way to improve working capital position of the firm.

Q8. What is limitations o Funds Flow Statement?

Ans: Following are the limitations o Funds Flow Statement:

1. It should be remembered that a funds flow statement is not a substitute of an income statement or a balance sheet. It provides only some additional information as regards changes in working capital.

2. It cannot reveal continuous changes.

3. It is not an original statement but simply are-arrangement of data given in the financial statements.

4. It is essentially historic in nature and projected funds flow statement cannot be prepared with much accuracy.

5. Changes in cash are more important and relevant for financial management than the working capital.

Q9. What are the differences between Funds Flow Statement and Income Statement?

Ans: Following are the differences between Funds Flow Statement and Income Statement:

Funds Flow Statement

Income Statement

1. It highlights the changes in the financial position of a business and indicates the various means by which funds were obtained during a particular period and the ways to which these funds were employed.

It does not reveal the inflows and outflows of funds but depicts the items of expenses and incomes arrive at the figure of profit and loss.

2. It is complementary to income statement. Income statement helps the preparation Funds Flow Statement.

2. Income statement is not prepared from Funds Flow Statement.

3. While preparing funds flow statement both capital and revenue items are considered.

3. Only revenue items are considered.

4. There is no prescribed format for preparing a funds flow statement.

4. It is prepared in a prescribed format.


Q10. What are the difference between Funds Flow Statement and Balance Sheet?

Ans: Following are the difference between Funds Flow Statement and Balance Sheet: 

Funds Flow Statement

Balance Sheet

1. It is a statement of changes in financial position and hence is dynamic in nature.

1. It is a statement of financial position on a particular date and hence in static in nature.

2. It shows the sources and uses of funds in a particular period of time.

2. It depicts the assets and liabilities at a particular point of time.

3. It is a tool of management for financial analysis and helps in making decisions.

3. It is not of much help to management in making decisions.

4. Usually, Schedule of Changes in Working Capital has to be prepared before preparing Funds Flow Statement.

4. No such schedule of Changes in Working Capital is required. Rather profit and loss account is prepared.

Q11. State the procedure for preparing a funds flow statement.

Ans: Funds flow statement is a method by which we study changes in the financial position of a business enterprise between beginning and ending financial statements dates. Hence, the funds flow statement is prepared by comparing two balance sheets and with the help of such other information derived from the accounts as may be needed. Broadly speaking, the preparation of a funds flow statement consists of two parts:

1. Statement or Schedule of changes in working capital.

2. Statement of sources and application of funds.

1. Statement or Schedule of changes in working capital.

   Working capital means the excess of current assets over current liabilities. Statement of changes in working capital is prepared to show the changes in the working capital between the two balance sheet dates. This statement is prepared with the help of current assets and current liabilities derived from the two balance sheets.

Working capital= Current assets – Current liabilities.

The change in the amount of any current asset or current liability in the current balance sheet as compared to that of the previous balance sheet either results in increase or decrease in working capital. The total increase or total decreases are compared and the difference shows the net increase or net decrease in working capital.

2. Statement of sources and application of funds.

Funds Flow Statement is a statement which indicates various sources from which funds have been obtained during a certain period and the uses or applications to which these funds have been put during that period. This statement is prepared in two formats:

a. Report Form

b. T Form or An Account Form or Self Balancing Type.

Following are the sources from which funds generally flow into the business:

a. Funds from operations or trading profits.

b. Issue of shares.

c. Issue of Debentures and raising loans, etc.

d. Sale of fixed assets and long term or trade investments.

e. Non-Trading receipts.

f. Decrease in working capital


Following are the Application or uses of funds:

a. Funds lost in operation.

b. Redemption of preference share capital.

c. Repayment of loans or redemption of debentures, etc.

d. Purchase of any non-current or fixed asset.

e. Payment of dividends and tax.

f. Any other non-trading payment.


Q12. Write short notes on:


1. Funds from operation: Trading profits or the profits from operations of the business are the most important and major source of funds. Sales are the main source of inflow of funds into the business as they increase current assets but at the same time funds flow out of business for expenses and cost of goods sold. Thus, the net effect of operations will be a source of funds if inflow from sales exceeds the outflow for expenses and cost of goods sold and vice-versa.

2. Cash flows from operating activities: Operating activities are the principal revenue producing activities of the enterprise. The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise pay dividends, repay loans, and make new investments without recourse to external sources of financing. There are two methods of reporting cash flows from operating activities: the direct method and the indirect method.

3. Cash flows from investing activities: Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources intended to generate future income and cash flows.

4. Cash flows from financing activities: Financing activities are activities that result in changes in the size and composition of the owner’s capital and borrowings of the enterprise. Cash flows arising from financing activities are important because it is useful in predicting claims on future cash flows by providers of funds to the enterprise.


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