Class 8: IGNOU MBA – MMPC 004: Accounting for Managers
Unit 8: Funds Flow and Cash Flow Analysis
Overview of Unit 8:
Unit 8 focuses on Funds Flow and Cash Flow Analysis, which are vital for understanding the movement of funds and cash in a business. These tools help in assessing how well a company is managing its financial resources, ensuring liquidity, and maintaining operational efficiency. A thorough analysis of these statements can provide insights into a company's ability to generate cash and manage its finances.
Topics Covered in Unit 8:
8.1 Introduction to Funds Flow and Cash Flow Statements
- Funds Flow Statement: It provides a detailed analysis of the sources and uses of funds, showing the changes in financial position between two balance sheet dates.
- Cash Flow Statement: This statement explains the inflows and outflows of cash within a business, focusing on liquidity and cash management.
Key Differences:
- Funds Flow focuses on working capital changes, whereas Cash Flow focuses only on cash and cash equivalents.
- The Cash Flow Statement is prepared on a cash basis, while the Funds Flow Statement is prepared on an accrual basis.
8.2 Preparation of Funds Flow Statement
The Funds Flow Statement has two parts:
- Schedule of Changes in Working Capital: This part summarizes the changes in current assets and current liabilities to identify changes in working capital.
- Working Capital = Current Assets - Current Liabilities
- Increase in Working Capital: Indicates a positive flow of funds.
- Decrease in Working Capital: Indicates the use of funds.
Example of Schedule of Changes in Working Capital:
- Funds from Operations: This section calculates the funds generated from operating activities. It is similar to the operating profit figure but adjusted for non-cash items like depreciation.
Format of Funds from Operations:
8.3 Preparation of Cash Flow Statement
The Cash Flow Statement is divided into three sections:
-
Cash Flow from Operating Activities: Cash generated from core business operations.
- Direct Method: Cash received from customers - Cash paid to suppliers.
- Indirect Method: Starts with net income, then adjusts for non-cash transactions (e.g., depreciation, changes in working capital).
-
Cash Flow from Investing Activities: Cash used or generated from investments in long-term assets like property, plant, and equipment (PP&E), and investments.
-
Cash Flow from Financing Activities: Cash flows related to borrowing, repaying debt, issuing stock, and paying dividends.
Format of Cash Flow Statement (Indirect Method):
8.4 Analysis of Funds Flow and Cash Flow Statements
Analysis of Funds Flow Statement:
- Sources of Funds: Identify the origin of funds, whether from operations, loans, or other long-term sources.
- Uses of Funds: Where the funds are applied, such as for purchasing assets, repaying debt, or distributing dividends.
- Assessment: A healthy business generates more funds than it uses. Overuse of funds can indicate liquidity stress.
Analysis of Cash Flow Statement:
- Operating Cash Flow: A positive cash flow from operations indicates that the company is generating sufficient cash to cover its core activities.
- Investing Cash Flow: A negative figure usually suggests investment in future growth, but consistently large outflows may indicate excessive capital spending.
- Financing Cash Flow: Positive cash flow from financing can be beneficial for expansion, but too much reliance on debt can lead to financial strain.
8.5 Importance of Funds Flow and Cash Flow Analysis
- Liquidity Analysis: Helps in assessing the company’s short-term liquidity and its ability to meet obligations.
- Working Capital Management: Funds Flow highlights changes in working capital, allowing for better management of short-term resources.
- Cash Management: Cash Flow analysis shows how well a company generates cash and manages its inflows and outflows to sustain its operations.
- Investment Decisions: Investors use these statements to gauge a company's financial health and its ability to generate cash returns on their investments.
Experiments and Real-Life Examples
- Experiment: Prepare a Funds Flow and Cash Flow Statement for a small business using actual financial data over two years. Analyze the movement of funds and cash.
- Real-Life Example: Analyze the Cash Flow Statements of Reliance Industries and compare it with TCS. Evaluate which company has better cash generation from operating activities.
Assignment Questions
- Explain the difference between Funds Flow and Cash Flow Statements with examples.
- How do changes in working capital affect the preparation of a Funds Flow Statement? Illustrate with an example.
- What are the key components of a Cash Flow Statement? Explain their significance.
Self-Study Questions
- Why is Funds Flow analysis important for working capital management?
- How does Cash Flow analysis help in understanding a company’s liquidity position?
- Discuss the relationship between Funds Flow and Cash Flow in financial decision-making.
Exam Questions
- Differentiate between Cash Flow from operating, investing, and financing activities. Provide examples.
- Explain the concept of a Funds Flow Statement and describe the steps involved in its preparation.
- How can the analysis of Funds Flow and Cash Flow Statements aid in investment decisions?
Conclusion
In this class, we explored Funds Flow and Cash Flow analysis. These tools are essential for evaluating how a business manages its financial resources, ensuring liquidity, and understanding how funds are sourced and utilized. The analysis of these statements can provide insights into the company's ability to sustain operations, make investments, and manage debt.
