USES OF FUNDS
The following are the examples of uses of Funds:
1. Purchase of Any Fixed Assets
If any fixed asset is purchased for cash, it is an application of
fund.
2. Payments of Loans
Any repayment of loan of redemption in preference share is also an application of funds.
3. Payment of dividend
Pay of dividend reduces the working capital and is an application of funds. But mere declaration of dividend (proposed dividend) is not an application of fund.
4. Increase in working Capital
Increase in working Capital is also application of funds because it increase, the investment in current sales.
PREPARATION OF SOURCES AND USES STATEMENT:
A funds- or sources and uses statement is valuable aid to financial manager or a creditor in evaluation how these uses are financed. Such a statement provides an efficient method for the financial manager to asses the growth of the firm and its resulting financial needs and to determine the best way statements are very useful in planning intermediate and long term financing. It is an important tool of working capital analysis also.
Broadly speaking, the funds-flow statement consists of two parties-first is schedule of changes in working capital, and second is statement of sources and uses of funds.
Generally the statement is prepared in two formats viz., in Report Form and in Account Form.
Report from -
. SALE OF FIXED ASSETS , NON-TRADING RECEIPTS
When any fixed assets (like land, building, machinery furnitures of long-term investments) are sold cash or account receivable is increased without increasing current liability and hence results in the generation of funds.
NON-TRADING RECEIPTS
Any non-trading receipt like dividends, interest etc. received in cash also increases funds.
ISSUE OF SHARE CAPITAL & DEBENTURES
Increase in share capital increases funds but shares issued and allotted for other than cash consideration do not generate fund.
ISSUE OF OR LONG-TERM LOANS
Issue of debentures, accepted public deposits and long-term loans, all result in the increase of funds. If debentures, like shares, have been allotted to some body for other than cash consideration, they will not be taken in to account.
LOSS ON SALE OF ASSETS
The loss which has been debited to profit or Loss account, must be added to the profit in order to compute funds from incomes.
The following items are deducted from profits:
1. Divider; is Received from Outside:
Gelerally it is credited in P & L a/c. As it is a non-Nshiems income it is qlown separately as a source of funds, so, here, it worst 4educted from profits.
ii. Transfer of facess Provisions
It does not create any in-flow of funds, which profits are increased. Hence, it must be deducted.
iii. Profit or Gain on Sale of Assets
Any profit or gain on the sale of 919A1,9rwit assets (which has been credited to P & L a/c.) must be e ated from the amount of profit.
iv. Appreciation in the Value of Fixed Assets
If any fixed asset has been appreciated during the year and credited to P & L a/c, must also be deducted from the profit.
SOURCES OF FUNDS
The transactions that increase working capital are sources of funds. Some of them are:
1. FUNDS FROM OPERATIONS
Sales are the main source of funds inflow but at the same time funds-flow out for expenses and cost of goods sold. Thus, funds are increased if inflow from sales exceeds the outflow for expenses and goods sold. It can be calculated as under:
Calculation of funds from operations:
Net Profit shown as P & L a/c Rs.
ADD
(i) Depreciation and Depletion
(ii) Amortization of Fictitious and Intangible Assets
(iii) Provision for taxation
(iv) Appropriation of Retained Earnings
(v) Dividend (if any paid out of current years' profit)
(vi) Loss on sale of any assets (if debited) to P & L a/c
(vii) Any other non-cash expenditure
LESS
(i) Dividends Received from outside
(ii) Retransfer of excess provisions
(iii) Profit on sale of fixed Assets
(if already credited to P & L a/c)
(iv) Appreciation in the value of fixed Assets
(if credited in P & L a/c)
(v) Funds from operations.
USES AND SIGNIFICANCE OF KINDS-FLOW ANALYSIS
Funds-Flow analysis is a useful tool in the financial manager':', analytical kit. The bask purpbAd of this statement is to indicate where funds came from where theY Were used during the given period.
The utility of this analysis can be very well measured on the basis of the contributions it makes to the financial management. It provides the following main services:-
I. ANALYSIS OF YYNANCL41, OPERATIONS
A funds-flow statement gives us a rich insight into the financial operations of a firm - an insight 'which is specially valuable to the financial manager in analysing past and future expansion plants of the firm and the impact of these plants on liquidity. He can detect imbalances in the uses of funds and undertake appropriate actions.
2. EVALUATION OF THE FIRM'S FINANCING
One important use of funds-flow statement is the evaluation of the firm's financing. An analysis of the major sources of funds in the past reveals what position of the firm's growth was financed internally and what position externally. Fund statement is also useful in judging whether the firm has expanded at too fast a rate and whether financing is strained.
3. A TOOL OF COMMUNICATION
The use of the source and application of funds statement as tool of communication should also not be forgotten. It clearly defines the past flow of funds and gives insight into the evaluation of the present situation. The financial manager of the company uses it to spotlight the causes of present financial strain to answer the question of, 'where our resources have been moving?'.
It provides certain useful information to bankers, creditors and government, etc., for which they do not require to approach the top management specially. In fact, it is a good communique of firm's financial policies to the outside world.
4. FUTURE GUIDANCE
An analysis of a fund statement for the future is extremely valuable to the Financial manager in planning the intermediate and long-term financing of the firm. It tells him the firm's total prospective need for funds, the expected timing of these needs and their nature too. On the basis of this information, along with the expected changes in trade payable and the various accruals, he can arrange the firm's financing more effectively.
5.PROFITABLE BUT LESS LIQUID
A firm may be profitable but poor in repayments. It can be verified and improved through Funds Flow Analysis.
6. MEANS OF PLANNING
The funds-flow analysis acts as a means of Planning tool and solves critical problems and financial complexities.
7. SHAREHOLDERS BE MOTIVATED
It gives clear picture of funds where from coming and going where by which shareholders would know funds position clearly and get motivated to invest.
UTILISATION OF FUND FLOW
The Funds Flow analysis is widely used by the financial analysis and credit granting institutions and financial managers in performance of their jobs. It has become a useful tool in their analytical kit. This is because the financial statements i.e., 'Income Statement' and the 'Balance Sheet' have a limited role to perform.
Income Statement measures flows restricted to transactions that pertain to rendering of goods or service Statements. It is a statement of assets and liabilities as on a particular date. It does not sharply focus those major financial transactions which have been behind the Balance Sheet.
For example, if the fixed assets worth Rs. 2 lakhs are purchased during the current year by raising share capital of Rs. 2 lakhs the balance sheet will simply show a high capital figure and higher fixed assets figure. In case, one compares the current years Balance Sheet with the previous year's Balance Sheet then only one can draw an inference that fixed assets were acquired by raising share capital of Rs. 2 lakhs. Similarly, "certain important transactions which might occur during the course of the accounting year might not find any place in the balance sheet. For example, if a loan of Rs. 2 lakhs was raised and paid in the accounting year, the Balance Sheet will not depict this transaction. However, a financial analyst must know the purpose for which the loan was utilised and the source from which it was raised. This will help
him in making a better estimate about the company's financial position and policies.
FUND FLOW ANALYSIS
MEANING OF FUNDS
The 'term 'funds' has a variety of meanings. There are people who take it synonymous to cash and to them there is no difference between a Funds Flow Statement and a Cash Flow Statement. While others include marketable securities besides cash in the definition of the term 'Funds'. The International Accounting Standard No. 7 on `Statement of Changes in Financial Position' also recognises the absence of single, generally accepted, definition of the term. The term 'Funds' generally refers to cash and cash equivalents, or to working capital. Of these, the last definition of the term is by far the most common definition of 'Fund'.
MEANING OF 'FUNDS-FLOW
The term 'funds' has been defined in a number of ways. Some interpret 'funds' as 'cash' only and fund-flow statement prepared on this basis is called a cash-flow statement. In this type of statement only inflow and outflow of cash are taken in to account. For its preparation the net income is adjusted for the amount of the increases or decreases in accounts receivable, inventories, accrued revenue and expenses, etc. This type of statement is prepared specially for the use of management in predicting future cash requirements.
TOOLS OF FINANCIAL ANALYSIS
1, COMPARAT1VE 0Iv,1,NCIAL AND OPERATING STATEMINTS
The principal ratio of comparative' financial and operating statements is an important devise of horizontal financial any Financial data becomes more meaningful. similar data for a previous period of a number of prior periods. Statements prepared in a form that reflect financial data for two or more periods are known as comparative statements.
Annual data can be compared with similar data for prior years. Such statements are very ta taful in measuring the effects of the conduct of a business during the period for both types of financial statements- balance sheet as well as profit and loss account.
The comparative profit and loss accounts will present a review of operating activities of the business. The comparative balance sheet shows the • effect of operatioas on the assets and liabilities, i.e., change in the financial position during the period under consideration.
2. COMMON SIZE STATEMENTS
Comparative statements that give only the vertical percentage of ratios for financial data Without giving rupee values are known as common size statements.
They are also known as 100 statements. For example, if the balance sheet items are expressed as the ratio of each asset to total assets and the ratio of each liability to total liabilities (taking the total of balance sheet as 100), it will be called a common size balance sheet.
Thus, a common size statement shows the relation of each component to the whole. It is useful in vertical financial analysis and comparison of two business enterprise at a certain date.
3. TREND ANALYSIS
Trend analysis is also an important tool of horizontal financial analysis. Under this technique of financial analysis the ratios of different items for various periods are calculated and then a comparison is made. An analysis of the ratios over the past few years may well suggest the trend or direction in which the concern is going upward or downward.
4, AVERAGE ANALYSIS
It is an improvement over trend analysis method. When trend ratios have been determined for the concern, these figures are compared with industry averages. These both trends can be presented on the graph paper also in the shape of curves. This presentation of facts in the shape olpictures Makes the analysis and comparison more comprehensive and impressive.
5. STATEMENT OF CHANGES IN WORKING CAPITAL
To discuss the increase or decrease in working capital over a period of time the preparation of a statement of changes in working capital is also very useful. The main objective of this statement preparation is to derive a fairly accurate summary of the events that affected the amount of working capital, The amount of net working capital-is determined by deducting the total of current liabilities from the total of the current assets.
Hence, it is a rough statement which may be prepared by using balanced sheet data only. But it does not explain the detailed reason for the changes in working capital and methods of financing additional requirements of working capital. Hence, the preparation of funds-flow statement becomes necessary.
6. FUNDS-FLOW AND CASH-FLOW ANALYSIS
Funds-flow analysis is available aid to the financial executives and creditors for evaluating the uses of funds by the firm and in determining how these uses were financed.
A funds-flow statement indicates where funds came from and where they were used during the period under review. These statements can be prepared separately also as funds-flow statements and cash-flow statements. There are important tools of communication and very helpful for financial executives in planning the intermediate and long-term financing of the firm.
7. RATIO ANALYSIS
Ratio analysis is an important and widely used tool of analysis of financial statements. It is essentially an attempt to develop meaningful relationship between individual items (or groups of items) in the balance sheet or profit and loss account.
The objects and utility of ratio analysis as a technique of financial analysis, confined not only to the internal parties but to the creditors, banks and lending institutions also.
It functions as a sort of health test. In the nut-shell rate analysis gives the answer of the following problems; whether the enterprises' financial position is basically sound, whether the capital structure of the business is in proper order, whether the profitability of the enterprise is satisfactory, whether the credit policy in relation to sales and purchases is sound and whether the company is credit worthy. Thus, ratio analysis highlights the liquidity, solvency, profitability and capital gearing, etc.
TYPES OF FINANCIAL ANALYSIS
Distinction between the different types of financial analysis can be made either on the basis of material used for the same or according to the modus operandi of the analysis or the object of the analysis.
1. EXTERNAL ANALYSIS
External analysis of financial statement is made by those who do not have access to the detailed accounting those who do not have access to the detailed accounting records of the company, i.e., banks, creditors and general public. Those people depend almost entirely on published financial statements. The main objective of such analysis varies from party to party.
2. INTERNAL ANALYSIS
Such analysis is made by the finance and accounting department to help the top management. These people have direct approach to the relevant financial records so they can peep behind the two basic financial statements (Balance Sheet and Income Statement) and narrate the inside story. Such analysis emphasizes on the performance appraisal and assessing the profitability of different activities.
3. SHORT-TERM ANALYSIS
The short-term analysis of financial statement is mainly concerned with the working capital artalysi::. tn.: short run a company must have ample funds readily avaitabit- its current needs and sufficient borrowing capacity to meet that.
Hence in short-term analysis the current assets andtae current liabilities are analysed and cash position (liquidity) et the concern is determined.
4. LONG-TERM ANALYSIS
In the Long-term the company must earn a minimum amount sufficient to maintain a suitable rate of return n thv inve\imerit to provide for the necessary growth and deaclopnana la; company and to meet the cost of capital. Financial planning is also n, essaryfor the continued sta. cess of a company. 111,1,: in thc long-riavalysis, the stress is on the stability and carnin-1 potent;,,H of I he 34
concern. In long-term analysis the fixed assets, long-term debt structure and the ownership interest are analysed.
The short-term and long-term both type of analysis are important. Proper planning for the future, requires fairly sufficient knowledge of the company's current position which may be determined from short-term financial analysis, only. The need of short-term analysis for long-term planning is useful in the same way as driver, consulting a road map for the best route to his destination, must know his present location exactly.
5. HORIZONTAL ANALYSIS
When financial statements for a number of years of a company reviewed and analyzed the analysis is called 'horizontal analysis'. The preparation of comparative statement is an example of horizontal analysis. As it is based on data from year to year, rather than on one date or period to time as a whole, this is also known as 'Dynamic Analysis'.
6. VERTICAL ANALYSIS
Vertical analysis is also know as 'Static' analysis. When ratios are calculated from the balance sheet of one year, it is called vertical analysis. It is not very useful for long-term planning as it does not include the trend study for future.