Funds Flow and Cash Flow Analysis
Funds flow: working-capital basis
"Funds" here means net working capital (current assets − current liabilities). The funds flow statement lists sources (issue of shares and debentures, long-term loans, sale of fixed assets, non-operating income, decrease in working capital) and applications (redemption of shares or debentures, purchase of fixed assets, payment of dividend and tax, increase in working capital). It is preceded by a schedule of changes in working capital.
Cash flow: three activities
Following the indirect method: start with net profit before tax, add back non-cash and non-operating items (depreciation, goodwill written off, interest, loss on sale of assets), adjust for changes in current assets and current liabilities, then deduct tax paid. Classify under operating, investing and financing activities.
Worked example
Profit after tax ₹5,00,000; depreciation ₹1,00,000; debtors increase ₹60,000; creditors increase ₹40,000; tax paid nil for simplicity. Cash from operations = 5,00,000 + 1,00,000 − 60,000 + 40,000 = ₹5,80,000. Reasoning: depreciation is a non-cash charge, so it is added back; a rise in debtors means revenue not yet collected, so it is subtracted; a rise in creditors means expenses not yet paid, so it is added. Note the cash flow statement ignores the funds flow statement's working-capital subtotal entirely.
Traps that cost marks
Treating profit as cash; forgetting the depreciation add-back; adding instead of subtracting an increase in a current asset; deducting an increase in a current liability; confusing funds (working capital) with cash; misclassifying purchase or sale of fixed assets as operating; treating a bank overdraft as a financing inflow in one question and a current liability in another without stating the assumption.