Concept Of "Flow" In Funds Flow Statement

The term "flow" means change or movement of funds in terms of net working capital.It means inflow or increase and outflow of decrease of fund, ie. net working capital, as a result of certain financial transactions that have taken place in the firm during the specific period.All financial transactions finally affect the balance sheet, but they all do not affect the net working capital of the firm.There are certain class of transactions which cause an increase of funds, while the other cause a decrease of funds in the firm.Therefore,identifying changes in net working capital requires an understanding of the effects of the financial transactions on net working capital.The financial transactions which increase current assets or decrease current liabilities with corresponding decrease in fixed assets or increase in long-term liabilities and capital create inflow or increase in funds or net working capital.On other hand, the transaction which decrease current assets or increase current liabilities with corresponding increase in fixed assets or decrease in long -term liabilities and capital cause outflow or decrease in funds or net working capital.The types of transactions other than these do not affect net working capital and hence do not cause flow of funds in and out of the firm.

The following types of transactions cause change(increase or decrease) of funds.
1.Transactions involving current liabilities and non-current liabilities.
2.Transactions involving current liabilities and non-current assets.
3.Transactions involving current assets and non-current assets.
4.Transactions involving current assets and non-current liabilities and owner's equity.
5.Transactions involving non-operating receipts and non-operating loss.

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Concept Of "Funds" In Funds Flow Statement

The term "funds" has more than one meaning. In its narrow sense,the term funds is used to mean cash, at most people think that funds and cash are the same thing. In funds flow statement, however cash is not used as a basis,because it concentrates only on changes in a single asset, cash.Instead,the term funds is used in the broader sense of working capital,as it focuses on changes in broader category of working capital.Therefore the term funds is used to mean working capital in the funds flow statement.However, there are two concepts of working capital, ie. gross concept and net concept. The gross concept of working capital means the firm's total investment in its current assets.In its net concept,working capital is the difference between firm's current assets and current liabilities,such that:

Net Working Capital = Current Assets - Current Liabilities

In other word, the net working capital is the excess of current assets over current liabilities. In funds flow statement, the term funds is used to mean net working capital,as it is closely related to the operating cycle of the business.

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Importance Of Funds Flow Statement

Funds flow statement is an important financial tool, which analyze the changes in financial position of a firm showing the sources and applications of its funds. It provides useful information about the firm's operating, financing and investing activities during a particular period. The following points highlight the importance of funds flow statement.

1. Funds flow statement helps in identifying the change in level of current assets investment and current liabilities financing.
2. Funds flow statement helps in analyzing the changes in working capital level of a firm.
3. Funds flow statement shows the relationship of net income to the changes in funds from business operation.
4. Funds flow statement reports about past fund flow as an aid to predict future funds flow.
5. Funds flow statement helps in determining the firms' ability to pay interest and dividend, and pay debt when they become due.
6. Funds flow statement shows the firms' ability to generate long-term financing to satisfy the investment in long-term assets.
7. Funds flow statements helps in identifying the factor responsible for changes in assets, liabilities and owners' equity at two balance sheet date.

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Concept Of Statement Of Changes In Financial Position

A joint stock company is required to prepare and publish financial statements annually . The financial statement shows the financial affairs of the company. The financial statements include statement of income, statement of retained earnings and balance sheet.

* Statement of income : It is a summarized statement of revenues earned and expenses incurred by the company for a specific period of time. It reports the results of business operations in terms of net profit or loss.

* Statement of retained earnings : This statement is also called profit and loss appropriation account. It presents the summary of changes that have occured in retained earnings over the specific period generally a year.

* Balance sheet: It is a summary statement of assets , liabilities and the owners' equity of the company. It gives the snapshot view of its financial position at the end of the specific period.

There is yet another important type of financial statements that a joint stock company has to prepare and is called the statement of changes in the financial position. The statement in changes in the financial position is a summarized statement of changes or movement of financial resources in the firm for the period covered by the firm's income statements. It shows the movement or flow of financial resources in and out of the firm during the period of two balance sheet dates. It shows the sources and uses of financial resources. The statement of changes in financial position can be prepared on cash, net working capital or all financial resources basis. The statement of changes in financial position prepared on net working capital basis is popularly called funds flow statement. This statement presents the sources and application of net working capital during a specific period of time.

Funds Flow Statement

The funds flow statement is the statement of change or movement of funds of the firm for the specific period of time. Funds flow statement shows the sources and application of fund during the period. The funds flow statement is a statement which is prepared to show and analyze the change, movement or flow of funds of the firm during a period of two balance sheet periods. It lists the sources of funds and its uses in the firm during the period.

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Limitations Of Ratio Analysis

Although ratio analysis is very important tool to judge the company's performance , following are the limitations of it.

1. Ratios are tools of quantitative analysis, which ignore qualitative points of view.

2. Ratios are generally distorted by inflation.

3. Ratios give false result, if they are calculated from incorrect accounting data.

4. Ratios are calculated on the basis of past data. Therefore, they do not provide complete information for future forecasting.

5. Ratios may be misleading, if they are based on false or window-dressed accounting information.

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Concept And Types Of Profitability Ratios

The main objective of a company is to earn profit. Profit is both a means and end to the company. Therefore, profitability shows the overall efficiency of the company. Profitability ratios are the measure of its overall efficiency. Generally, profitability ratios can be calculated in term of company's sale, investments and earnings and dividends. The following are the main types of profitability ratios.

1.Profitability in relation to sales

*Gross profit margin

*Net profit margin

2. Profitability in relation to investment

*Return on assets (ROA)

*Return on shareholders equity (ROSE)

*Return on equity shareholders fund

*Return on capital employed

3. Profitability in terms of earnings and dividends

* Earning per share (EPS)

* Dividend per share (DPS)

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Concept And Types Of Turnover Ratios

Turnover ratios are also known as activity or efficiency ratios. The total fund raised by the company are invested in acquiring various assets for its operations. The assets are acquired to generate the sales revenue and the position of profit depends upon the value of sales. Turnover ratios establish the relationship of sales with various assets. Turnover ratios are expressed in integers or times rather than as a percentage or proportion. The turnover ratios are mostly computed to measure the efficiency.

Types Of Turnover Ratios
1. Inventory turnover ratio
2. Debtors turnover ratio
3.Average collection period
4. Total assets turnover ratio
5. Fixed assets turnover ratio
6. Capital employed turnover ratio

1. Inventory Turnover Ratio
Inventory turnover ratio is also known as stock turnover ratio.Inventory turnover ratio shows the relationship between the cost of good sold and the average inventory. This ratio measures how frequently the company's inventory turned into sales. This ratio is calculated by using the following formula.
Inventory turnover ratio = Cost of good sold/Average stock = ........... times.
In the absence of the cost of good sold and average stock, the following formula can be used to calculate inventory turnover ratio.
Inventory turnover ratio = Sales/Closing Inventory = .......... times.

* Cost Of Good Sold = Opening stock+ Purchases+Carriage inward+Direct wages and expenses- Closing Stock
* Cost Of Good Sold =Sales - Gross profit
* Average stock = (Opening stock + closing stock)/2

2. Debtors Turnover Ratio
Debtors turnover ratio is also called receivable turnover ratio. This ratio establishes the relationship between net credit sales and average debtors for the year. Debtors turnover ratio shows how quickly the credit sales of the company have been converted into cash. This ratio can be calculated by using the following formula

Debtors Turnover Ratio = Net credit sales/Average account receivable

* The term account receivable includes 'trade debtors and bills receivable'.

3. Average Collection Period

Average collection period is also called debt collection period or average age of debtors and receivables. It indicates how long it takes to realize the credit sales or debtors and receivables. Average collection period also measures the average credit period enjoyed by the customers. It indicates the average time lag between credit sales and their conversion into cash. This ratio is calculated by using following formula.
Average Collection Period = Days in a year/debtors turnover ratio= ......... days.
Or,
Average Collection Period =(Average debtors/Credit Sales)Days in a year= .... days.

4. Total Assets Turnover Ratio
Total assets turnover ratio shows the relationship between total assets and sales. Total assets turnover ratio indicates how well the firm's total assets are being used to generate its sales. This ratio is obtained by using the following formula.
Total Assets Turnover ratio = Net Sales/Total Assets

5. Fixed Assets Turnover Ratio

Fixed assets turnover ratio is also termed as the ratio of sales to fixed assets. Fixed assets turnover ratio indicates how efficiently the fixed assets are used. It measures the efficiency with which the firm has been using its fixed assets to generate sales. This ratio is calculated in the following manner.

Fixed Assets Turnover Ratio = Sales/ Net fixed assets.

6. Capital Employed Turnover Ratio
Capital employed turnover ratio establishes the relationship between the amount of sales and capital employed. It shows how efficiently capital employed in the company has been utilised in generating sales revenue. This ratio is calculated by using following formula.

Capital Employed Turnover Ratio = Sales/Capital employed

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