Flow of Funds | Procedure for finding flow of funds

What is flow of funds?

Flow means movement. The term movement includes inflow and outflow. Here, flow of funds means transfer of economic values from one asset of equity to another. In other words, flow of funds refers to movement of funds in the working capital.

A business transaction may bring a change in working capital either in the form of decrease or increase. If there is change in current assets and current liabilities in the same direction and by the same amount, there will be change only in their amount but no change in the working capital. Hence, there is no flow of fund in such type of transaction.

In simple words, there is a flow of funds if a transaction affects

  1. a current asset and a fixed asset or
  2. a fixed and a current liability or
  3. a current asset and a fixed liability or
  4. a fixed liability and current liability.

There is no flow of funds if the transaction assets fixed assets and fixed liability or current assets and current liabilities.

Procedure For Finding The Flow Of Funds

The following procedure can be adopted to find the flow of funds from a transaction.

  1. A detailed analysis of a specific transaction.
  2. Find the accounts involved in the specific transaction. Generally, there are two accounts involved.
  3. Out of two accounts, find whether the involved accounts are current or fixed in nature.
  4. If both accounts are current in nature, there is no flow of funds.
  5. If both accounts are fixed in nature, there is no flow of funds.
  6. If one account is current in nature and another account is fixed in nature, there is a flow of funds.

The following example disclose the flow of funds very clearly.

Example:

  1. Cash paid to creditors Rs.10,000.
  2. Purchase of building in exchange of Equity Shares Rs.50,000
  3. Issues of Debentures for cash Rs.1,00,000.
  4. Purchase of Plant and Machinery from M/s. Anand & Co., on credit Rs.75,000.

The above transactions are analyzed to find the flow of funds.

First Transaction: Cash paid to Creditors.

Step 1: Two accounts are involved. They are cash a/c and creditors a/c.

Step 2:

Inference: Both accounts are current in nature, hence, there is no flow of funds.

Second Transaction: Purchase of building in exchange of Equity Shares.

Step 1: Two accounts are involved. They are Building a/c and Equity Share Capital a/c.

Step 2:

Inference: Both the accounts are fixed in nature, hence, there is no flow of funds.

Third Transaction: Issue of Debentures for cash.

Step 1: The accounts are involved. They are Cash a/c. and Debentures a/c.

Step 2:

Inference: Out of two accounts, one account is current in nature and another account is fixed in nature. Hence, there is a flow of funds.

Fourth Transaction: Purchase of plant & machinery from M/s. Anand & Co., on credit.

Step 1: Two accounts are involved. They are Plant and Machinery a/c and M/s. Anand & Co., a/c.

Step 2:

Inference: Out of two accounts, one account is current in nature and another account is fixed in nature. Hence, there is a flow of funds.

The following picture shows the flow of funds very clearly.

Flow of Funds

Image: Flow of Funds

Related Post

Zero based budgeting | Stages | Advantages | Disadvantages Understanding Zero based budgeting Zero based budgeting is used as a managerial tool to control the costs. It got popularity since the early 1970's. ...
Yardsticks for ratio analysis An efficiency of an individual can be assessed only by fixing the standard. If not so, the concerned individual has no option of knowing his level of ...
Working capital | Operating Cycle or Circular Flow Concept Working Capital Working capital refers to a part of sources of funds of a business concern used for financing short term purposes or current assets s...
Working capital | Meaning | Needs | Balance Sheet Concept What is working capital? Working capital is the amount used to meet the day to day operation activities of a business. In the broad sense, the term w...
Who is a Management Accountant | Role in Management The management accounting system provides highly useful economic and financial data to the management. A channel is used to transmit the information e...
Who is a Budget Officer? | What are his Duties or Functions? Who is a Budget Officer? Budget Officer is a head of Budgetary Control Organization. He/she may be otherwise called as the Budget Director or Budget ...

Leave a Reply