Since WC includes cash, the WC basis is taken up first for discussions before taking up the cash basis. SCFP is to identify sources and uses of funds; and accordingly, sources and uses of WC are first listed for information.
(a) Sources of Working Capital
In-house (A- 1) Funds (inflow) from business operations (profit)
(A-2) Other incomes (including sale of investments)
(A-3)
Extemally (A-4) Long-term borrowings (or loans)
(A-5) Sale of non-current (fixed) assets
Additional Issue of Equity Capital or Preference Share Capital, i.e. raising of capital
(b) Uses (or Application) of Working Capital
In-house (B-I) Losses (outflow) from business operations
(B-2) Purchase of non-current (fixed) assets and investments
Extemally (B-3) Interest payments to be made
(B-4) Repayment (or Redemption) of debenturesfloans andlor preference shareslcapital
(B-5) Dividend to preference shareholders and ordinary shareholders
Funds from Business Operations
P & L A/c (Income Statement) records a number of items which are either write-offs (i.e.amortisations) or adjustments but not involving any receipts or disbursements of funds,per se. Such items arise out of past decisions primarily and perhaps also due to current period's decisions. Adjustments have to be made to the profit (or net income) reported in the P & L Alc to compute the funds from business operations.
Method 1 : Adjustment to Profit (Working Results)
All expenses which have been deducted from (sales) revenue (or sales income) but which do not reduce WC and so are called non-fund items are to be added back.Examples are : Depreciation, provisions; (Excess in) provisions for income tax;and bad and doubtful debts; Amortisation of goodwill, patents and other intangible assets; and of discounts on debentures, and of share issue expenses; amortisation of extra-ordinary losses of previous years and of preliminary expenses; loss on sale of non-current (fixed) assets and investments; dividends proposed to be paid out;and also interest (or servicing) expenses (which have to be listed in full in an accompanying statement).Items which have been added to revenue but have not contributed to WC (being non-fund items again) are to be deducted. These include : Amortisation of investment tax credit; amortisation of premium received on debentures; profit and sale of equipment or fixed assets; profit on revaluation of non-current assets or investments.
All such revenues which are not directly caused by business operations should also be deducted. These include : Transfer fees (which have to be listed in detail in an accompanying statement); Dividends and interests received on investments (which also have to be listed in detail in an accompanying statement).Funds from business operations will be the Profit reported in P & L Nc, plus the additions as discussed above, minus the two sets of indicated deductions. This method is called Adjustment to Profit or Adjustment of Working Result. In this method, to restate in lieu of the additions and subtractions to be made, it may be said that the net profittloss for the period (called working result) is readjusted for non-fund items and for appropriations and provisions (including write-offs or amortisations).
Method 2 : Adjustment on Balance of P & L A/c
The closing balance of the P & L N c is adjusted for nowfund items, i.e. those given under the first list under Method 1 (viz. depreciation, appropriations and provisions) are added and those given under the second list under Method 1 (viz.credit for unearned receipts) are sl~btracted, and finally further corrected fof (by subtracting) the opening balance of the P & L Alc. The addition of the said non-fund items makes it that only business or operating revenues providing WC on the income side are taken in; and subtraction of the said non-fund items makes it that only business or operating revenues providing WC on the income side are taken in; and the subtraction of the said non-fund items makes it that only those operating expenses which involve the use of WC are incorporated. The balancing figure in such an adjustment statement therefore represents the amount of net WC generated or provided by (if a profit) or used by (if a loss) the business operations of the period under review.This is the most usually followed method, being easier in concept appreciation and also in practising.
Method 3 : Recasting the P & L A/c (or, Statement of Retained Earnings).
(a) Sources of Working Capital
In-house (A- 1) Funds (inflow) from business operations (profit)
(A-2) Other incomes (including sale of investments)
(A-3)
Extemally (A-4) Long-term borrowings (or loans)
(A-5) Sale of non-current (fixed) assets
Additional Issue of Equity Capital or Preference Share Capital, i.e. raising of capital
(b) Uses (or Application) of Working Capital
In-house (B-I) Losses (outflow) from business operations
(B-2) Purchase of non-current (fixed) assets and investments
Extemally (B-3) Interest payments to be made
(B-4) Repayment (or Redemption) of debenturesfloans andlor preference shareslcapital
(B-5) Dividend to preference shareholders and ordinary shareholders
Funds from Business Operations
P & L A/c (Income Statement) records a number of items which are either write-offs (i.e.amortisations) or adjustments but not involving any receipts or disbursements of funds,per se. Such items arise out of past decisions primarily and perhaps also due to current period's decisions. Adjustments have to be made to the profit (or net income) reported in the P & L Alc to compute the funds from business operations.
Method 1 : Adjustment to Profit (Working Results)
All expenses which have been deducted from (sales) revenue (or sales income) but which do not reduce WC and so are called non-fund items are to be added back.Examples are : Depreciation, provisions; (Excess in) provisions for income tax;and bad and doubtful debts; Amortisation of goodwill, patents and other intangible assets; and of discounts on debentures, and of share issue expenses; amortisation of extra-ordinary losses of previous years and of preliminary expenses; loss on sale of non-current (fixed) assets and investments; dividends proposed to be paid out;and also interest (or servicing) expenses (which have to be listed in full in an accompanying statement).Items which have been added to revenue but have not contributed to WC (being non-fund items again) are to be deducted. These include : Amortisation of investment tax credit; amortisation of premium received on debentures; profit and sale of equipment or fixed assets; profit on revaluation of non-current assets or investments.
All such revenues which are not directly caused by business operations should also be deducted. These include : Transfer fees (which have to be listed in detail in an accompanying statement); Dividends and interests received on investments (which also have to be listed in detail in an accompanying statement).Funds from business operations will be the Profit reported in P & L Nc, plus the additions as discussed above, minus the two sets of indicated deductions. This method is called Adjustment to Profit or Adjustment of Working Result. In this method, to restate in lieu of the additions and subtractions to be made, it may be said that the net profittloss for the period (called working result) is readjusted for non-fund items and for appropriations and provisions (including write-offs or amortisations).
Method 2 : Adjustment on Balance of P & L A/c
The closing balance of the P & L N c is adjusted for nowfund items, i.e. those given under the first list under Method 1 (viz. depreciation, appropriations and provisions) are added and those given under the second list under Method 1 (viz.credit for unearned receipts) are sl~btracted, and finally further corrected fof (by subtracting) the opening balance of the P & L Alc. The addition of the said non-fund items makes it that only business or operating revenues providing WC on the income side are taken in; and subtraction of the said non-fund items makes it that only business or operating revenues providing WC on the income side are taken in; and the subtraction of the said non-fund items makes it that only those operating expenses which involve the use of WC are incorporated. The balancing figure in such an adjustment statement therefore represents the amount of net WC generated or provided by (if a profit) or used by (if a loss) the business operations of the period under review.This is the most usually followed method, being easier in concept appreciation and also in practising.
Method 3 : Recasting the P & L A/c (or, Statement of Retained Earnings).
The P & L Alc is prepared afresh with fitting in the debit and credit items appropriately; the balancing figure represents the operational inflow (or, if so, loss).The balance of the profit at the end of the year is adjusted as in Method 1. Then amounts transferred to general reserves or other reserves (like for amortisations, for dividend payments), i.e. the appropriations out of profits, are added back, the rationale, as is obvious, being that these transactions entail conveniences of reclassification of the funds originating from the operations without actually involving any using up of the WC. (Note that payment of dividends, though a "use" of the funds from business operations, is primarily only out of funds generated by the operations, as far as constitution of WC is concerned. It is first retained before being distributed.) Finally, the opening balance of profit of the year is to be deducted, as is again only obvious. The balancing figure represents, as above said, the operational inflow.
Note on Provision for Bad and Doubtful Debts
It has been said under Method 1 that this provision has to be added to adjust on the working result. However, opinion also exists that no adjustment must be made; and this opinion is based on the premise that sales revenue (or the operational inflow) would have already been less by the amount of bad and doubtful debts. Since such a premise is most often the reality in reporting the sales revenue, no adjustment for provision of bad and doubtful debts would be in order in such cases. In any case, it may be safe to omit this adjustment, except if it affects the retained earnings.
Note on Loss on Sale of Investments and on Inflow due to Sale Proceeds
Regarding loss on sale of investment, two related facts are to be noted, viz. this loss is reduced from the profit when reporting the profit; also there is no outflow of funds. For the latter reason, this is added back. As regards inflow due to sale proceeds (i.e. cost received less the loss), this is understandably an addition to WC.
Regarding Provision for Taxation
If provision for taxation is added back to profit, the result is taken as gross operational (funds) flow, as a result of having considered the payment of tax during the year, as an outflow, but yet retained for the present till imminent. This provision will constitute the due tax outgoes deferred for the moment, within current liabilities in determining the WC. However, if net operational (funds) flow is discussed, this being post-tax, there is no more pending outflow as payment of tax. To recall, gross operational flow is the flow before making provision for tax (and hence, also for dividend).
Note on Provision for Bad and Doubtful Debts
It has been said under Method 1 that this provision has to be added to adjust on the working result. However, opinion also exists that no adjustment must be made; and this opinion is based on the premise that sales revenue (or the operational inflow) would have already been less by the amount of bad and doubtful debts. Since such a premise is most often the reality in reporting the sales revenue, no adjustment for provision of bad and doubtful debts would be in order in such cases. In any case, it may be safe to omit this adjustment, except if it affects the retained earnings.
Note on Loss on Sale of Investments and on Inflow due to Sale Proceeds
Regarding loss on sale of investment, two related facts are to be noted, viz. this loss is reduced from the profit when reporting the profit; also there is no outflow of funds. For the latter reason, this is added back. As regards inflow due to sale proceeds (i.e. cost received less the loss), this is understandably an addition to WC.
Regarding Provision for Taxation
If provision for taxation is added back to profit, the result is taken as gross operational (funds) flow, as a result of having considered the payment of tax during the year, as an outflow, but yet retained for the present till imminent. This provision will constitute the due tax outgoes deferred for the moment, within current liabilities in determining the WC. However, if net operational (funds) flow is discussed, this being post-tax, there is no more pending outflow as payment of tax. To recall, gross operational flow is the flow before making provision for tax (and hence, also for dividend).
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