Cash Flow and Funds Flow Analysis

Cash Flow and Funds Flow statement analysis involves various tools and techniques to assess a company’s financial health and performance.

Among these, funds flow analysis and cash flow analysis are crucial for understanding a company’s liquidity, solvency, and operational efficiency.

1. Cash Flow Statement:
   1. Statement tracks the movement of cash into and out of a business over a specific period, usually monthly, quarterly, or annually.
   2. It categorizes into three main sections: operating activities, investing activities, and financing activities.
   3. Operating activities include cash generated from the company’s core business operations, such as revenue from sales and payments to suppliers.
   4. Investing activities involve cash flows related to the purchase and sale of long-term assets, such as property, plant, and equipment, as well as investments in securities.
   5. Financing activities include the company’s capital structure, such as issuing or repurchasing stock, borrowing or repaying loans, and paying dividends.
   6. The cash flow statement helps stakeholders understand how a company generates and uses cash, which is crucial for assessing its liquidity and ability to meet short-term obligations.
2. Funds Flow Statement:
   1. A funds flow statement, also known as a statement of changes in financial position, focuses on changes in a company’s financial position between two balance sheet dates.
   2. It analyses the sources and uses of funds over a specific period to determine how the company’s financial position has changed.
   3. Unlike the cash flow statement, which focuses on cash transactions, the funds flow statement considers both cash and non-cash transactions.
   4. Funds flow analysis typically categorizes changes in funds into two main sections: sources of funds and uses of funds.
   5. Sources of funds include increases in working capital, additional borrowings, proceeds from asset sales, and other inflows that contribute to the company’s financial resources.
   6. Uses of funds include repayment of debt, investments in assets, payment of dividends, and other outflows that reduce the company’s financial resources.
   7. The funds flow statement provides insights into the company’s long-term financial health, capital structure, and investment decisions.

Let’s explore each of these analyses, their formulas, and provide live examples to illustrate their importance.

Funds Flow Analysis:

Funds flow analysis focuses on changes in a company’s financial position over a specific period, emphasizing the sources and uses of funds. It helps in understanding how funds are generated and utilized within the organization.

Formula:

Net Increase in Working Capital = Increase in Current Assets−Increase in Current Liabilities 

Example:

Suppose Company XYZ reports the following changes in its balance sheet over a year:

• Current Assets increase from 200,000 to 250,000.
• Current Liabilities increase from 150,000 to 180,000.

Using the formula:-

Net Increase in Working Capital = (250,000−200,000)−(180,000−150,000)  

50,000−30,000

20,000

This indicates a net increase in working capital of 20,000, suggesting that the company’s liquidity position has improved.

Cash Flow Analysis:

Analysis focuses on the inflow and outflow of cash within a company during a specific period. It helps assess a company’s ability to generate cash from its operating activities, invest in growth opportunities, and meet its financial obligations.

Formula:-

Cash Flow

From Operating Activities = Net Income + Non cash Expenses − Changes in Working Capital 

From Investing Activities = Cash Inflow from Sale of Assets − Cash Outflow from Purchase of Assets  

From Financing Activities = Cash Inflow from Borrowing or Equity Financing − Cash Outflow from Repayment of Debt or Equity Financing 

Example:

Let’s consider Company ABC’s cash flow statement for the year:

• Net Income: 100,000
• Depreciation Expense: 20,000
• Increase in Accounts Receivable: 10,000
• Sale of Equipment: 30,000
• Purchase of New Equipment: 40,000
• Issuance of Bonds: 50,000
• Repayment of Bank Loan: 20,000

1. Operating Activities = Net Income + Non cash Expenses − Changes in Working Capital 

From Operating Activities 100,000+20,000−10,000 = 110,000

2. Investing Activities = Cash Inflow from Sale of Assets − Cash Outflow from Purchase of Assets  

From Investing Activities = 30,000−40,000 = −10,000

3. Financing Activities = Cash Inflow from Borrowing or Equity Financing − Cash Outflow from Repayment of Debt or Equity Financing 

From Financing Activities = 50,000−20,000 = 30,000

Net Cash Flow = From Operating Activities + From Investing Activities + From Financing Activities

110,000+(−10,000)+30,000

 130,000

The positive net cash flow of 130,000 indicates that the company generated more cash than it used during the period, reflecting a healthy cash position.

Importance of Funds Flow and Cash Flow Analysis:

• Liquidity Assessment: Funds flow analysis helps assess changes in working capital, indicating a company’s ability to meet short-term obligations. Cash flow analysis provides insights into a company’s actual cash position, essential for liquidity management.
• Solvency Evaluation: Both analyses help assess a company’s ability to meet its long-term financial obligations. Funds flow analysis tracks changes in capital structure, while cash flow analysis assesses cash available for debt repayment and dividends.
• Operational Efficiency: Cash flow analysis highlights the cash generated from operating activities, reflecting the company’s ability to generate cash from its core business operations. It helps identify operational strengths and weaknesses.
• Investment and Financing Decisions: Both analyses aid in investment and financing decisions. Funds flow analysis helps in evaluating the sources of funds and their utilization, while cash flow analysis assists in assessing the cash available for investments and debt servicing.

Limitations of Funds Flow and Cash Flow Analysis:

• Historical Perspective: Both analyses rely on historical financial data and may not accurately predict future cash flows or financial performance.
• Non-cash Transactions: Cash flow analysis may not capture non-cash transactions, such as depreciation, impairments, or changes in accounting policies, which can impact the cash position.
• Complexity: Analysing funds flow and cash flow statements requires expertise and understanding of accounting principles, making it challenging for novice investors or analysts.