Balance Sheet and Profit and Loss Account are the two most important financial statements which are prepared at the end of the financial year. Balance Sheet (or Position Statement) shows financial position of an -undertaking i.e., assets and liabilities, as on a particular date. The Profit and Loss Account (or Income Statement) shows the result of operations i.e., profit or loss during the financial year. No doubt, these two financial statements reveal very useful information in Funds Flow Statement.
But these two statements have a serious limitation j. e. they fail to reveal the changes in assets and liabilities during the financial year. In the course of business operations, various assets, liabilities and capital undergo various changes during the financial year.
The knowledge of such changes and reasons of these changes is extremely useful to management of the company. For example, a company may have issued debentures to raise funds for the purchase of plant and machinery. But this information is not revealed by balance sheet
Funds Flow Statement and Profit and Loss Account
The main points of difference between the two are as follows:
1. Legal requirement. Preparation of Profit and Loss Account of a company is compulsory under law and has to be published as a part of Final Accounts. Preparation of Funds Flow statement is compulsory under law.
2. Purpose. Purpose of preparing Profit and Loss Account is to calculate net profit or loss on the other hand, the purpose of Funds Flow Statement is to calculate net increase or decrease in working capital of business during a period. In other words, Profit and Loss Account reveals profitability while
Funds Flow Statement reveals liquidity.
3. Items recorded. Profit and Loss Account records items of revenues and expenses while funds flow Statement records source and applications of funds i.e. net working capital.
4. Types of activities. Profit and Loss Account provides information about operating activities a business while Funds Flow Statement provides information about its financial and investing activities.
5. Types of accounts. Profit and Loss Account deals with nominal accounts while funds flow Statement deals with non-current accounts.
Funds Flow Statement and Balance Sheet
The main points of distinction between funds flow statement and Balance sheet are as follows:
1. Legal requirements. Preparation of Balance sheet of a company is compulsory and it has to be prepared as per schedule VI of the companies Act. Preparation of Funds Row Statement is not compulsory under law.
2. Purpose. Purpose of preparing Balance Sheet is to show the financial position of a business as on a particular date while the purpose of Funds Row Statement is to show net increase or decrease in working capital during a period.
3. Basis of preparation. Balance sheet is prepared on the basis of trial balance and additional information while Funds Flow Statement is prepared on the basis of two consecutive balance sheets and additional information.
4. Type of information. Balance Sheet shows assets, liabilities and capital at a point of time while Funds Flow Statement reveals flow of funds during a period of time i.e. movement of resources.
5. Types of accounts. Balance Sheet contains balance of personnel and real accounts while Funds Flow Statement deals with those accounts which affect working capital i.e. non-current accounts.
Uses of Funds Flow Statement
1. Helps in borrowing. Bank and other financial institutions like IDBI, State Finance Corporations etc. like to satisfy themselves about the ability of the company to repay the loan. Before lending, these institutions like to see projected Funds Flow Statements which indicates ability or otherwise of the company to pay off the loan as per the teams of repayment.
Problems and Solutions
State with reasons whether the following transactions result in increase or decrease of working capital or do not affect working capital.
(a) Issue of equity shares of Rs. 250,000 for cash.
(b) Land was exchanged for machinery worth Rs. 1,50,000.
(c) Sold goods costing Rs. 25,000 for Rs. 30,000.
(d) Debtors of Rs. 10,000 paid cash.
(e) Purchased machinery for Rs. 75,000 in cash. (B.Com. Ban galore, Adapted)
(a) Increase. This transaction increases cash (current asset) by Rs. 2,50,000 without affecting current liabilities. Thus it will increase working capital by Rs. 2,50,000.
(b) Increase. Increase in cash by Rs. 30,000 (current asset) and decrease in inventories by Rs.25,000 (current asset) resulting net increase in current assets of Rs. 5,000. Thus it will increase working capital by Rs. 5,000.
(d) Decrease. As cash is decreased, working capital will also decrease by Rs. 75,000.
State whether the following transactions increase or decrease or do not affect the working capital and give reasons:
(a) A company issues Rs. 1,00,000 worth of shares for cash.
(b) Redemption of Debentures worth Rs. 2,00,000.
(c) Amount received from Debtors Rs. 32,000.
(d) Amount paid to creditors Rs. 15,000.
(e) Plant sold for Rs. 40,000.
(f) Raw materials purchased Rs. 60,000 from ZB Co. on credit basis.
(g) Furniture purchased Rs. 40,000.
(h) Purchased plant worth Rs. 1,00,000 by issuing equal amount of Debentures of Rs. 500 each.
(i) Paid Rs. 20,000 towards the cost of issue of shares.
(j) Debentures worth Rs. 1,00,000 redemed by raising a long-term loan of equal amount.
(a) Increase. It increases cash (current asset) without affecting any current liability. Thus it increases net working capital.
(b) Decrease. It reduces cash without affecting any current liability. Thus working capital decreases.
(C) No Change. It increases cash and decreases debtors by the same amount. Since both of these items are current assets, the working capital does not change.
(d) No Change. It decreases cash (current asset) and also decreases creditors (current liability) by the same amount. Thus working capital does not change.
(e) Increase. It increase, cash (current asset) but decreases plant (fixed asset). Increase in current asset results in increase in working capital.
(f) No change. Stock of materials as well as creditors increase. This means current assets and current liabilities increase by the same amount. This does not affect working capital
(g) Decrease. Furniture (fixed asset) increases but cash (current asset) decreases. Thus working capital is decreased.
(h) No change. Plant and debentures are both non-current items. It does not affect working capital.
(i) Decreases. It decreases cash resulting in decrease in working capital.
(j) No change. Both debentures and long-term loan are non-current liabilities. Thus this transaction does not affect working capital.