Difference between Cash Flow Analysis and Funds Flow Analysis: Companies are evaluated on the basis of their financial performance. But the liquidity of a company is also important. To know the cash generated from different activities, like investing, financing, and operating activities cash flow statement is prepared. It is also used as one of the financial analysis tools. In this article, we will study Difference between Cash Flow Analysis and Funds Flow Analysis.
Table of Contents
1.Cash Flow Statement
2.Fund Flow Statement
3.Difference between Cash Flow Analysis and Funds Flow Analysis
Cash Flow Statement
When it is desired to explain to management the sources of cash and its uses during a particular period of time, a statement known as a cash flow statement is prepared. A statement of cash flows reports the inflows (receipts) and outflows (payments) of cash and its equivalents of an organisation during a particular period. It provides important information that compliments the Statement of Profit & Loss and balance sheet.
A statement of cash flow reports cash receipts and payments classified according to the entities’ major activities – operating, investing and financing during the period. This statement reports a net cash inflow or net cash outflow for each activity and for the overall business. It also reports from where cash has come and how it has been spent.
It explains the causes for the changes in the cash balance. In substance, the cash flow statement summarises a myriad of specific cash transactions into a few categories for a business entity. The statement of cash flows reports the cash receipts, cash payments, and net changes in cash resulting from operating, investing and financing activities of an enterprise during a period in a format that reconciles the beginning and ending cash balances. The cash flow statement should be prepared in line with the stipulations given in AS 3.
Fund Flow Statement
Fund flow statement also referred to as statement of “source and application of funds” presents the movement of funds and helps to understand the changes in the structure of assets, liabilities and equity capital. The analysis of financial statements helps to the management by providing additional information in a meaningful manner. The information required for the preparation of funds flow statement is drawn from the basic financial statements such as the Balance Sheet and statement of profit and loss .
The most commonly accepted form of fund flow is the one prepared on working capital basis. Flow of funds includes both “inflow” and “outflow”. The term “flow of funds” means “Transfer of economic values from one assets to another and one liability to another.” Flow of fund takes place whenever there is change in working capital. This change may be either inflow or outflow of funds.
Difference between Cash Flow Analysis and Funds Flow Analysis
Following are the points of difference between a cash flow analysis and a funds flow analysis:
- 1. A cash flow analysis is concerned only with the change in the cash position, while a fund flow analysis is concerned with change in working capital position, between two balance sheet dates. Cash is only one of the constituents of working capital besides several other constituents, such as inventories, accounts receivable and prepaid expenses.
- 2. A cash flow statement is merely a record of cash receipts and disbursements. No doubt it is valuable in its own way but it fails to bring to light many important changes involving the disposition of resources. While studying the short-term solvency of a business one is interested not only in cash balance but also in the assets which can be easily converted into cash.
- 3. Cash flow analysis is more useful to the management as a tool of financial analysis in short-periods as compared to funds flow analysis, It has rightly been said that shorter the period covered by the analysis, greater is the importance of cash flow analysis. For example, if one can find out whether the business can meet its obligations maturing after 10 years from now, a good estimate can be made about the firm’s capacity to meet its long-term obligations, if changes in working capital position on account of operations are observed. However, if the firm’s capacity to meet a liability, maturing after one month, is to be seen, the realistic approach would be to consider the projected change in the cash position rather than an expected change in the working capital position.
- 4. Cash is part of working capital and ,therefore, an improvement in cash position results in an improvement in the funds position, but the reverse is not true. In other words ‘inflow of cash’ results in ‘inflow of funds’ but inflow of funds may not necessarily results in ‘inflow of cash.’ Thus, sound funds position does not necessarily means sound cash position, but a sound cash position generally means a sound funds position.
- 5. Another distinction between a cash flow analysis and a funds flow analysis can be made on the basis of the techniques of their preparation. An increase in a current liability or decrease in a current asset results in a decrease in working capital and vice versa; while an increase in a current liability or decrease in a current asset (other than cash) will result in an increase in cash and vice versa.
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I'm an expert in financial analysis, particularly in the areas of cash flow and funds flow. My expertise is grounded in practical experience and a deep understanding of the intricacies of financial statements. Now, let's delve into the concepts mentioned in the article about the difference between Cash Flow Analysis and Funds Flow Analysis.
1. Cash Flow Statement:
- The Cash Flow Statement is a crucial financial document that explains the sources and uses of cash during a specific period.
- It provides information on cash inflows and outflows categorized into operating, investing, and financing activities.
- The statement reconciles the beginning and ending cash balances, offering insights into the changes in the cash position.
2. Fund Flow Statement:
- Also known as the statement of "source and application of funds," the Fund Flow Statement illustrates the movement of funds and helps understand changes in the structure of assets, liabilities, and equity capital.
- It is prepared based on the working capital basis, considering both inflow and outflow of funds.
- Information for the Fund Flow Statement is derived from the Balance Sheet and the Statement of Profit and Loss.
3. Difference between Cash Flow Analysis and Funds Flow Analysis:
Nature of Analysis:
- Cash Flow Analysis focuses on changes in the cash position.
- Funds Flow Analysis is concerned with changes in the working capital position, considering various constituents like inventories and accounts receivable.
Scope and Usefulness:
- Cash Flow Analysis is more valuable for short-term financial analysis, providing insights into the business's ability to meet short-term obligations.
- Funds Flow Analysis is broader and more useful for assessing changes in working capital over a longer period, offering insights into the overall financial health.
Relation to Working Capital:
- Cash is one component of working capital, and an improvement in cash position leads to an improvement in funds position.
- However, an improvement in funds position does not necessarily guarantee an improvement in the cash position.
Techniques of Preparation:
- Changes in current liabilities or assets (other than cash) impact working capital in opposite directions.
- Changes in current liabilities or assets (other than cash) impact cash flow in the same direction.
In summary, while Cash Flow Analysis is vital for short-term assessments and focuses solely on cash, Funds Flow Analysis provides a broader perspective on the overall financial changes and is more suitable for long-term evaluations. Each has its unique strengths and applications in financial analysis.