FLOW OF FUNDS



In accounting, the term "funds" has two distinct meanings: (1) cash and (2) the access of current assets over current liabilities, which is called "net working capital." Current assets refer to anything of value that a company will sell, use, or otherwise obtain cash for during the current year or operating cycle, whichever is longer, such as cash, inventories, and debt owed to a company. Current liabilities are obligations a company owes within the same period, such as money a company owes another party, insurance, taxes, and wages. Besides these two meanings, the term "funds" also can refer to a combination of cash and working capital.

The flow of funds, therefore, denotes the earning and spending of cash or the growth and reduction of working capital—i.e., fund inflows and outflows. Fund inflows include activities designed to produce revenues, such as selling products, services, investments, and other company assets, as well as issuing stocks and bonds. On the other hand, fund outflows include paying wages, obtaining insurance, purchasing company assets and materials, making long-term investments, and paying dividends and taxes. At one point, companies gauged their flow of funds by using any definition of funds and included a financial statement reporting these activities in their annual reports.

The original statements depicting the flow of funds had a number of different names, including: statement of sources and uses of funds, statement of sources and applications of funds, and statement of changes in financial position. These statements also were called "funds statements" for short. Stated in cash and cash-equivalents, the statement of changes in financial position demonstrated either the sources and uses of working capital and changes in each working capital account, or changes in cash. When preparing a funds statement, an accountant would obtain much of the needed information from the beginning and ending balance sheets, the income statement, and statement of retained earnings for the designated accounting period.

Investors, creditors, and financial managers monitor the flow of funds in order to determine how effectively management plans and controls the quantity and types of its resources, how it has invested and plans to invest company resources, and what methods it uses to finance them. Though once this entailed using the funds statement, financial statement users now obtain this information largely from cash flow statements, income statements, and balance sheets. Depending on whether financial statement users want to analyze cash flow or working capital, they can choose between the beginning and ending balance sheets of a specific accounting period to evaluate a company's working capital or the cash flow statement of the same period to evaluate a company's cash activities. Financial statement users can examine these statements together to monitor both working capital and cash activities.

Users of financial statements employ comparative analysis of this information over a number of years to better evaluate a company's performance and to enhance their ability at predictive decision making. Users analyze the trends to determine the degree to which funds, derived from operations, contribute to the growth of the company.

In addition, stockholders and creditors find analyzing the flow of funds helpful in understanding the changes in assets and asset sources. Analyzing the flow of funds helps stockholders and creditors determine how a company used its additional resources derived from profitable operations and to identify the financial strengths and weaknesses of the business. This additional information is essential to evaluating managerial performance and to making investment decisions. Creditors are more able to determine how the business uses credit and the debt capacity of the business.

Within a company, managers monitor the flow of funds particularly when planning and budgeting. From analyzing a series of relevant financial statements over a number of years, management can project cash requirements needed for growth, identify and plan the efficient use of idle funds, determine working capital requirements, ease the impact of insufficient cash balances, and plan the payment of interest to creditors and dividends to stockholders.

KEY ACCOUNTING BOARD OPINIONS

In 1963 the Accounting Principles Board (APB) of the American Institute of Certified Public Accountants, which established accounting standards at the time, issued Opinion No. 3 suggesting the inclusion of the Statement of Changes in Financial Position, as a supplement in financial reports. By 1972 Opinion No. 19 noted that regulatory agencies required the preparation of funds statements because the information contained therein was essential to financial statement users. Opinion No. 19 required presentation of such a statement each time a company presented a balance sheet and income statement. Also, the opinion mandated that companies prepare fund statements in accordance with the all-financial-resources concept under the title of "Statement of Changes in Financial Position."

APB No. 19 provided for the summarization of financial and investing activities along with funds generated from operations during a given accounting period. It also required the complete disclosure of changes in financial position. To be meaningful, a statement had to focus on a specific aspect or dimension of a financial position (e.g., cash, working capital, net assets, monetary assets) because a statement could not portray, in an understandable way, all effects of all activities on all possible measures of financial position.

Because of the ambiguous usage of the term "funds," however, the nongovernmental regulatory agency that succeeded the APB, the Financial Accounting Standards Board (FASB), encouraged companies to avoid using the term in its financial statements beginning in 1988. The FASB adopted Statement of Financial Accounting Standards No. 95 (FASB 95) in 1987, which provided the standards for cash flow reporting and replaced Opinion No. 19. Prior to FASB 95, the FASB required companies to issue a statement of changes in financial position, along with other the required financial statements: the balance sheet, the income statement, and the statement of retained earnings. Although the cash flow statement is the official name of the document replacing the statement of changes in financial position, some companies and books refer to the cash flow statement as a statement of changes in financial position.

[ Karl Heil ]

FURTHER READING:

APB Opinion No. 19, Reporting Changes in Financial Position. Accounting Principles Board, AICPA, 1971.

Bierman, Harold, Jr., and Seymour Smidt. Financial Management for Decision Making. Macmillan Publishing, 1986.

Brigham, Eugene F. Fundamentals of Financial Management. Fort Worth, TX: Dryden Press, 1995.

Fess, Philip E., and Carl S. Warren. Managerial Accounting. Cincinnati: South-Western Publishing, 1985.

Helfert, Erich A. Techniques of Financial Analysis. New York: Irwin, 1994.

Meigs, Robert F., and Walter B. Meigs. Accounting: The Basis for Business Decisions. 8th ed. New York: McGraw-Hill, 1990.

Rue, Joseph C., and Florence Kirk. "Settling the Cash Flow Statement Dispute." National Public Accountant, June 1996, 17.



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