The most commonly accepted meaning of the term fund is the working capital of the business which denotes excess of current assets over current liability.
There will be a flow of fund in case the working capital position of the company changes on account of any transaction.
The company realizes Rs20000/- from its debtors. The transaction will reduce the debtors from Rs80000 to 60000 but increase the cash balance from the present balance of Rs 20000 to Rs40000. Thus the total current assets continue at the old figure of Rs 30000.
This means this transaction will not bring any change in the working capital of the company. It is simply a conversion of current assets into another current asset.
Thus there is no flow of fund.
The company sells its building having a book value of Rs50000 at the sum of Rs 60000. This transaction will cash balance with the company from Rs20000 to Rs80000. The total current assets will be increased by Rs60000. Thus the transaction has brought a change in the working capital position.
From the above, the following general rules can be formed –
1) There will be the flow of fund if a transaction involves-
i) Current assets & fixed assets .eg. purchase of building for cash.
ii) Current assets and capital eg. The issue of share for cash
iii) Current assets and fixed liability., eg. Redemption of debenture for cash.
iv) Current liability & fixed liability eg. Creditors paid up in debentures.
v) Current liability & capital eg. Creditors paid off in shares.
vi) Current liability and fixed assets. eg: Building transferred to creditors in satisfaction of their claims.
There will be no flow of funds if a transaction involves –
i) Current asset and current liability eg. Payment made to creditors.
ii) Fixed asset and fixed liability eg. Building purchased and payment made in creditors
iii) Fixed asset and capital eg. Building purchased and payment made in shares.
Cash Flow Analysis Vs Fund Flow Analysis
1) It is concerned only with the change in cash position.
1) It is concerned with the change in working capital position between two balance sheet dates.
2) A cash flow statement is merely a record of cash receipt and disbursement. Of course, it is valuable in its own ways but it fails to bring to light many important changes involving the disposition of sources.
2) 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 converted into cash. This information is available in the fund flow statement.
3) It is more useful to the management as a tool of financial analysis in a short period 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.
3) If it is to be found out whether the business can meet its obligations maturing after 10years from now, a good estimate can be made about firm’s capacity to meet its long-term obligations if the change in working capital on account of operation are observed.
4) Cash is apart of working capital and therefore an improvement of cash position results in improvement in the fund position, but the reverse is not true.
Inflow of cash result in inflow of funds but inflow of funds may not necessarily result in inflow of cash. Thus a sound fund position does not necessarily mean a sound cash position but a sound cash position generally mean a sound fund position.
Some people use the term fund in a very narrow sense of cash only. In such an event the two terms fund and cash will have synonymous meaning.
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