Under Previous Section , in the term "funds flow", the word "funds" had referred to working capital, i.e. current assets less current liabilities. But if all other items of CA and CL other than bank balance and cash are excluded, "funds" would connote the truncated content of "cash" only. And, if this alone is analysed, one has "cash flow analysis" done. Albeit that funds flow analysis protrays long-term financing and investment activities,funds flow analysis can be prepared also for shorter durations than a year, if so needed.
Even then, in funds flow analysis, inventories and amounts receivable (i.e. book debts) are clubbed with cash on hand. And any increase in accounts payable and accrued expenses are treated equivalently with bank overdraft. Then, even though availability of sufficient net working capital be indicated, yet the firm may not be able to meet its current liabilities as and when they fall due (to be paid out), say, payment of salaries and wages may fall due ten days hence, but amounts receivable may be received at best after twenty days and inventories can perhaps be converted to money assets only over the next forty days. In short, in spite of a sound long-range financial position and adequate profitability (say by the time inventories get converted to money assets), the firm is insolvent to the extent that it might not be able to pay out wages and salaries ten days hence. So, to make plans for the more immediate future (i.e. for short-range planning),the firm has to develop statements regarding (expected) cash flows - to keep up its solvency - to meet its obligations to trade creditors, to pay back loans, to pay out dividends and to redeem debentures. With sufficient forethought and well-prepared cash flow statements for consecutive months to follow (cash flow projection statement prepared for monthly, or lesser intervals, is called cash budget), the firm may be able to schedule to meet such obligations, and, to the extent needed, to arrange for overdrafts or other securedlunsecured loans, or sell some of its assets. These cash flow statements depict (and project) sources of cash inflows and uses of cash outflows.
The salient point may be emphasised. Sound funds position does not necessarily mean sound cashlbank balance position. But sound cash/bank balance position and assured quanta of cash inflow may mean sound funds position, provided the funds are not diverted to non-fund items, i.e. towards non-current assets or towards paying out on "provisions".
Preparing Cash Flow Statement
The difference between funds flow statement and cash flow statement is in respect of resources provided by business operations. That is, for preparing cash flow statement,funds from operations must be based on items which correspond to cash from operations. Also, other items to be included in cash flow statement should be those that involve receipts or payments-by cash, e.g. issue of equity, or preference, shares, sale or purchase of non-current (i.e. fixed) assets (say, buildings, equipment), debentures and loans raised. In other words, if accruals and prepaid items are taken out from operational funds flow, position on cash flow remains residually.
Even then, in funds flow analysis, inventories and amounts receivable (i.e. book debts) are clubbed with cash on hand. And any increase in accounts payable and accrued expenses are treated equivalently with bank overdraft. Then, even though availability of sufficient net working capital be indicated, yet the firm may not be able to meet its current liabilities as and when they fall due (to be paid out), say, payment of salaries and wages may fall due ten days hence, but amounts receivable may be received at best after twenty days and inventories can perhaps be converted to money assets only over the next forty days. In short, in spite of a sound long-range financial position and adequate profitability (say by the time inventories get converted to money assets), the firm is insolvent to the extent that it might not be able to pay out wages and salaries ten days hence. So, to make plans for the more immediate future (i.e. for short-range planning),the firm has to develop statements regarding (expected) cash flows - to keep up its solvency - to meet its obligations to trade creditors, to pay back loans, to pay out dividends and to redeem debentures. With sufficient forethought and well-prepared cash flow statements for consecutive months to follow (cash flow projection statement prepared for monthly, or lesser intervals, is called cash budget), the firm may be able to schedule to meet such obligations, and, to the extent needed, to arrange for overdrafts or other securedlunsecured loans, or sell some of its assets. These cash flow statements depict (and project) sources of cash inflows and uses of cash outflows.
The salient point may be emphasised. Sound funds position does not necessarily mean sound cashlbank balance position. But sound cash/bank balance position and assured quanta of cash inflow may mean sound funds position, provided the funds are not diverted to non-fund items, i.e. towards non-current assets or towards paying out on "provisions".
Preparing Cash Flow Statement
The difference between funds flow statement and cash flow statement is in respect of resources provided by business operations. That is, for preparing cash flow statement,funds from operations must be based on items which correspond to cash from operations. Also, other items to be included in cash flow statement should be those that involve receipts or payments-by cash, e.g. issue of equity, or preference, shares, sale or purchase of non-current (i.e. fixed) assets (say, buildings, equipment), debentures and loans raised. In other words, if accruals and prepaid items are taken out from operational funds flow, position on cash flow remains residually.
Cash from Business Operations
The information given in next Section can be elaborated as under. Funds from operations under WC concept are based on accrual principle, i.e. sales, whether credit or cash, are recognised as source of WC; similarly, purchases, be they credit or cash, are recognised as use of WC. But, for computing cash from operations, only cash basis of accounting is admitted. Cash sales and cash receipts from debtors against credit sales -are taken for sources of cash. Cash purchases and cash payments to suppliers for credit purchases - are taken for uses of cash. Likewise, for other incomes and expenses, outstanding incames (due) and prepaid expenses (against would-be purchases) are to be appropriately considered. This leads to the following implementation.
(a) Every item in P & L A/c is to be viewed on the basis of cash transaction only and non-cash transactions are set aside. Like in funds flow statement,depreciation on plant and equipment and amortisation of the several deferred revenue expenses, shown in P & L A/c, involving no corresponding outflow of funds are to be added back.
(b) All increases in CA (except cash) and all decreases in CL, which increase WC - will have the effect of decreasing cash.
(c) S1. No. (b) is understandable by the fact that, when paid in cash, CL is decreased, be it creditors, bank overdrafts, bills or dividends payable. As regards increase in CA (except cash) resulting in decrease of cash, the following instances would clarify :
If sales are more than cash collections, CA in the form of sundry debtors increases. This needs the reduction of WC by the amount of this difference.Inventories, as component of CA, increase when cost of goods purchased is more than cost of goods sold. This difference too needs to'be reduced from WC to determine cash from business as the balance.
Pre-paid expenses, as component of CA, increase WC by the making out of more of cash payment than is the worth of the current services
received till then.
(d) The converse of S1. No. (b) also applies, i.e. all decreases in CA (other than cash) and all increases in CL, which decrease WC will have the effect of increasing cash. The following illustrations refer here :
Debtors are CA; when they pay what is owed by them, cash collections exceed current sales, i.e. cash increases as CA decreases.If cost of goods sold exceeds cost of goods purchased, firstly cash increases, and secondly, by the same token, inventories decrease, i.e.CA decreases.If quantum of pre-paid expenses, as component of CA, decreases,WC decreases simultaneously with implying decrease in cash. Note that decrease in prepaid expense suggests that the company has paid. less (cash) for services than (as the services) are being currently used.
The information given in next Section can be elaborated as under. Funds from operations under WC concept are based on accrual principle, i.e. sales, whether credit or cash, are recognised as source of WC; similarly, purchases, be they credit or cash, are recognised as use of WC. But, for computing cash from operations, only cash basis of accounting is admitted. Cash sales and cash receipts from debtors against credit sales -are taken for sources of cash. Cash purchases and cash payments to suppliers for credit purchases - are taken for uses of cash. Likewise, for other incomes and expenses, outstanding incames (due) and prepaid expenses (against would-be purchases) are to be appropriately considered. This leads to the following implementation.
(a) Every item in P & L A/c is to be viewed on the basis of cash transaction only and non-cash transactions are set aside. Like in funds flow statement,depreciation on plant and equipment and amortisation of the several deferred revenue expenses, shown in P & L A/c, involving no corresponding outflow of funds are to be added back.
(b) All increases in CA (except cash) and all decreases in CL, which increase WC - will have the effect of decreasing cash.
(c) S1. No. (b) is understandable by the fact that, when paid in cash, CL is decreased, be it creditors, bank overdrafts, bills or dividends payable. As regards increase in CA (except cash) resulting in decrease of cash, the following instances would clarify :
If sales are more than cash collections, CA in the form of sundry debtors increases. This needs the reduction of WC by the amount of this difference.Inventories, as component of CA, increase when cost of goods purchased is more than cost of goods sold. This difference too needs to'be reduced from WC to determine cash from business as the balance.
Pre-paid expenses, as component of CA, increase WC by the making out of more of cash payment than is the worth of the current services
received till then.
(d) The converse of S1. No. (b) also applies, i.e. all decreases in CA (other than cash) and all increases in CL, which decrease WC will have the effect of increasing cash. The following illustrations refer here :
Debtors are CA; when they pay what is owed by them, cash collections exceed current sales, i.e. cash increases as CA decreases.If cost of goods sold exceeds cost of goods purchased, firstly cash increases, and secondly, by the same token, inventories decrease, i.e.CA decreases.If quantum of pre-paid expenses, as component of CA, decreases,WC decreases simultaneously with implying decrease in cash. Note that decrease in prepaid expense suggests that the company has paid. less (cash) for services than (as the services) are being currently used.
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