Meaning Of Fund Flow Statement: A Fund Flow Statement Is

Objectives of Cash Flow Statement:Cash Flow Statement is prepared to fulfill some objectives.Some of the main objectives of Cash Flow Statement are:1. It shows the cash earning capacity of the firm.2. It indicates different sources from which cash been collected and various purposes for whichcash has been utilised during the year.3. It classifies cash flows during the period from operating, investing and financing activities.4. It gives answers to various perplexing questions often encountered by management, such as whythe firm is unable to pay dividend instead of making enough profit? Why is there huge idle cashbalance in spite of loss suffered? Where have the proceeds of sale of fixed assets gone? etc.5. It helps the management in cash planning and control so that there are no shortage or surplus ofcash at any point of time.6. It evaluates the ability of the firm to meet obligations such as loan repayment, dividends, taxesetc.7. A prospective investor consults the cash flow statement to ensure that his investment gets regularreturns in future.8. It discloses the reasons for differences among net income, cash receipts and cash payments.9. It helps the management in taking capital budgeting decisions more scientifically. 10. It ensuresoptimum use of funds for the maximum benefit of the enterprise.Utility or Importance of Cash Flow Statement:Cash Flow Statement is useful for short-term planning and control of cash. A business entity needssufficient amount of cash to meet its various obligations in the near future such as payment forpurchase of fixed assets, payment of debts, operating expenses of the business etc.It helps the financial manager to make a cash flow projection for the immediate future taking thedata relating to cash inflows and cash outflows from past records. As such, it becomes easy for himto know the cash position which may either result in a surplus or a deficit one. Thus, cash flowstatement is another important tool of financial analysis for the management.Its main advantages are:1. Evaluation of Cash Position:It is very helpful in understanding the cash position of a firm. Since cash is the basis for carryingon business operations smoothly, the cash flow statement is very useful in evaluating the currentcash position of the business.2. Planning and Control:A projected cash flow statement enables the management to plan and coordinate the financialoperations properly. The financial manager can know how much cash is needed, from where it willbe derived, how much can be generated internally, and how much could be obtained from outside.3. Performance Evaluation:

A comparison of actual cash flow statement with the projected cash flow statement will disclose thefailure or success of the management in managing cash resources. Deviations will indicate the needfor corrective actions.4. Framing Long-term Planning:The projected cash flow statement helps financial manager in exploring the possibility of repaymentof long-term debts which depends upon the availability of cash.5. Capital Budgeting Decision:A projected cash flow statement also helps the management in taking capital budgeting decisions.6. Liquidity Position:Liquidity position of a firm refers to its ability to meet short-term obligations such as payment ofwages and other operating expenses etc. From cash flow statement the financial manager is able tounderstand how well the firm is meeting these obligations.At the same time the ability of the firm in cash earning can be known from cash flow statement. Asa matter of fact, a firm’s profitability is ultimately dependent upon its cash earning capacity.7. Answers to Different Questions:Cash flow statement is able to explain some questions often encountered by the financial managersuch as, why is the firm not able to pay dividend in spite of making huge profit? Why there is hugecash balance in spite of loss etc.Limitations of Cash Flow Statement:Cash Flow Statement is, no doubt, an important tool of financial analysis which discloses thecomplete story of cash management. The increase in—or decrease of—cash and reasons thereof, canbe known, However, it has its own limitation.These limitations are:1. Since cash flow statement does not consider non-cash items, it cannot reveal the actual netincome of the business.2. Cash flow statement cannot replace fund flow statement or income statement. Each of them hasa separate function to perform which cannot be done by the cash flow statement.3. The cash balance as disclosed by the projected cash flow statement may not represent the realliquid position of the business since it can be easily influenced by the managerial decisions, bymaking certain payments in advance or by post ponding payments.4. It cannot be used for the purpose of comparison over a period of time. A company is not better offin the current year than the previous year because its cash flow has increased.5. It is not helpful in measuring the economic efficiency in certain cases e.g., public utility servicewhere generally heavy capital expenditure is involvedMeaning of Ratio Analysis:

Ratio analysis refers to the analysis and interpretation of the figures appearing in the financialstatements (i.e., Profit and Loss Account, Balance Sheet and Fund Flow statement etc.).It is a process of comparison of one figure against another. It enables the users like shareholders,investors, creditors, Government, and analysts etc. to get better understanding of financialstatements.Khan and Jain define the term ratio analysis as “the systematic use of ratios to interpret thefinancial statements so that the strengths and weaknesses of a firm as well as its historicalperformance and current financial conditions can be determined.”Ratio analysis is a very powerful analytical tool useful for measuring performance of anorganisation. Accounting ratios may just be used as symptom like blood pressure, pulse rate, bodytemperature etc. The physician analyses these information to know the causes of illness. Similarly,the financial analyst should also analyse the accounting ratios to diagnose the financial health ofan enterprise.Generally, ratio analysis involves four steps:(i) Collection of relevant accounting data from financial statements.(ii) Constructing ratios of related accounting figures.(iii) Comparing the ratios thus constructed with the standard ratios which may be thecorresponding past ratios of the firm or industry average ratios of the firm or ratios of competitors.(iv) Interpretation of ratios to arrive at valid conclusions.Advantages of Ratio Analysis:Ratio analysis is widely used as a powerful tool of financial statement analysis. It establishes thenumerical or quantitative relationship between two figures of a financial statement to ascertainstrengths and weaknesses of a firm as well as its current financial position and historicalperformance. It helps various interested parties to make an evaluation of certain aspect of a firm’sperformance.The following are the principal advantages of ratio analysis:1. Forecasting and Planning:The trend in costs, sales, profits and other facts can be known by computing ratios of relevantaccounting figures of last few years. This trend analysis with the help of ratios may be useful forforecasting and planning future business activities.2. Budgeting:Budget is an estimate of future activities on the basis of past experience. Accounting ratios help toestimate budgeted figures. For example, sales budget may be prepared with the help of analysis ofpast sales.3. Measurement of Operating Efficiency:Ratio analysis indicates the degree of efficiency in the management and utilisation of its assets.Different activity ratios indicate the operational efficiency. In fact, solvency of a firm depends uponthe sales revenues generated by utilizing its assets.

4. Communication:Ratios are effective means of communication and play a vital role in informing the position of andprogress made by the business concern to the owners or other parties.5. Control of Performance and Cost:Ratios may also be used for control of performances of the different divisions or departments of anundertaking as well as control of costs.6. Inter-firm Comparison:Comparison of performance of two or more firms reveals efficient and inefficient firms, therebyenabling the inefficient firms to adopt suitable measures for improving their efficiency. The best wayof inter-firm comparison is to compare the relevant ratios of the organisation with the average ratiosof the industry.7. Indication of Liquidity Position:Ratio analysis helps to assess the liquidity position i.e., short-term debt paying ability of a firm.Liquidity ratios indicate the ability of the firm to pay and help in credit analysis by banks, creditorsand other suppliers of short-term loans.8. Indication of Long-term Solvency Position:Ratio analysis is also used to assess the long-term debt-paying capacity of a firm. Long-termsolvency position of a borrower is a prime concern to the long-term creditors, security analysts andthe present and potential owners of a business. It is measured by the leverage/capital structure andprofitability ratios which indicate the earning power and operating efficiency. Ratio analysis showsthe strength and weakness of a firm in this respect.9. Indication of Overall Profitability:The management is always concerned with the overall profitability of the firm. They want to knowwhether the firm has the ability to meet its short-term as well as long-term obligations to itscreditors, to ensure a reasonable return to its owners and secure optimum utilisation of the assetsof the firm. This is possible if all the ratios are considered together.10. Signal of Corporate Sickness:A company is sick when it fails to generate profit on a continuous basis and suffers a severeliquidity crisis. Proper ratio analysis can give signal of corporate sickness in advance so that timelymeasures can be taken to prevent the occurrence of such sickness.11. Aid to Decision-making:Ratio analysis helps to take decisions like whether to supply goods on credit to a firm, whetherbank loans will be made available etc.12. Simplification of Financial Statements:Ratio analysis makes it easy to grasp the relationship between various items and helps inunderstanding the financial statements.Limitations of Ratio Analysis:

The technique of ratio analysis is a very useful device for making a study of the financial health of afirm. But it has some limitations which must not be lost sight of before undertaking such analysis.Some of these limitations are:1. Limitations of Financial Statements:Ratios are calculated from the information recorded in the financial statements. But financialstatements suffer from a number of limitations and may, therefore, affect the quality of ratioanalysis.2. Historical Information:Financial statements provide historical information. They do not reflect current conditions. Hence, itis not useful in predicting the future.3. Different Accounting Policies:Different accounting policies regarding valuation of inventories, charging depreciation etc. make theaccounting data and accounting ratios of two firms non-comparable.4. Lack of Standard of Comparison:No fixed standards can be laid down for ideal ratios. For example, current ratio is said to be ideal ifcurrent assets are twice the current liabilities. But this conclusion may not be justifiable in case ofthose concerns which have adequate arrangements with their bankers for providing funds whenthey require, it may be perfectly ideal if current assets are equal to or slightly more than currentliabilities.5. Quantitative Analysis:Ratios are tools of quantitative analysis only and qualitative factors are ignored while computing theratios. For example, a high current ratio may not necessarily mean sound liquid position whencurrent assets include a large inventory consisting of mostly obsolete items.6. Window-Dressing:The term ‘window-dressing’ means presenting the financial statements in such a way to show abetter position than what it actually is. If, for instance, low rate of depreciation is charged, an itemof revenue expense is treated as capital expenditure etc. the position of the concern may be made toappear in the balance sheet much better than what it is. Ratios computed from such balance sheetcannot be used for scanning the financial position of the business.7. Changes in Price Level:Fixed assets show the position statement at cost only. Hence, it does not reflect the changes in pricelevel. Thus, it makes comparison difficult.8. Causal Relationship Must:Proper care should be taken to study only such figures as have a cause-and-effect relationship;otherwise ratios will only be misleading.9. Ratios Account for one Variable:

Since ratios account for only one variable, they cannot always give correct picture since severalother variables such Government policy, economic conditions, availability of resources etc. shouldbe kept in mind while interpreting ratios.10. Seasonal Factors Affect Financial Data:Proper care must be taken when interpreting accounting ratios calculated for seasonal business.For example, an umbrella company maintains high inventory during rainy season and for the rest ofyear its inventory level becomes 25% of the seasonal inventory level. Hence, liquidity ratios andinventory turnover ratio will give biased pictureClassification of Ratios:The use of ratio analysis is not confined to financial manager only. There are different partiesinterested in the ratio analysis for knowing the financial position of a firm for different purposes. Inview of various users of ratios, there are many types of ratios which can be calculated from theinformation given in the financial statements.The particular purpose of the user determines the particular ratios that might be used for financialanalysis. For example, a supplier of goods of a firm on credit or a banker advancing a short-termloan to a firm, is interested primarily in the short-term paying capacity of the firm, or say in itsliquidity.On the other hand, a financial institution advancing a long term credit to a firm will be primarilyinterested in the solvency or long- term financial position of the concern. Similarly, the interests ofthe owners (shareholders) and the management also differ. The shareholders are generallyinterested in the profitability or dividend position of a firm while management requires informationon almost all the financial aspects of the firm to enable it to protect the interests of all the parties.(A) Traditional Classification or Statement Ratios:Traditional classification or classification according to the statement, from which theseratios are calculated, is as follows:

(a) Balance Sheet or Position Statement Ratios:Balance Sheet ratios deal with the relationship between two balance sheet items, e.g. the ratio ofcurrent assets to current liabilities, or the ratio of proprietors’ funds to fixed-assets. Both the itemsmust, however, pertain to the same balance sheet. The various balance sheet ratios have beennamed in the chart classifying statement ratios.(b) Profit and Loss Account or Revenue/Income Statements Ratios:These ratios deal with the relationship between two profit and loss account items, e.g., the ratio ofgross profit to sales, or the ratio of net profit to sales. Both the items must, however, belong to thesame profit and loss account. The various profit and loss account ratios, commonly used, arenamed in the chart classifying statement ratios.(c) Composite/Mixed Ratios or Inter Statement Ratios:These ratios exhibit the relation between a profit and loss account or income statement item and abalance sheet item, e.g., stock turnover ratio, or the ratio of total assets to sales. The mostcommonly used inter-statement ratios are given in the chart exhibiting traditional classification orstatement ratios.(B) Functional Classification or Classification According to Tests:In view of the financial management or according to the tests satisfied, various ratios havebeen classified as below:(a) Liquidity Ratios:These are the ratios which measure the short-term solvency or financial position of a firm. Theseratios are calculated to comment upon the short-term paying capacity of a concern or the firm’sability to meet its current obligations. The various liquidity ratios are: current ratio, liquid ratio andabsolute liquid ratio. Further to see the efficiency with which the liquid resources have beenemployed by a firm, debtors turnover and creditors turnover ratios are calculated.(b) Long-term Solvency and Leverage Ratios:

Long-term solvency ratios convey a firm’s ability to meet the interest costs and repaymentsschedules of its long-term obligations e.g. Debt Equity Ratio and Interest Coverage Ratio. LeverageRatios show the proportions of debt and equity in financing of the firm. These ratios measure thecontribution of financing by owners as compared to financing by outsiders.The leverage ratios can further be classified as:(i) Financial Leverage,(ii) Operating Leverage,(iii) Composite Leverage.(c) Activity Ratios:Activity ratios are calculated to measure the efficiency with which the resources of a firm have beenemployed. These ratios are also called turnover ratios because they indicate the speed with whichassets are being turned over into sales, e.g., debtors turnover ratio. The various activity or turnoverratios have been named in the chart classifying the ratios.(d) Profitability Ratios:These ratios measure the results of business operations or overall performance and effectiveness ofthe firm, e.g., gross profit ratio, operating ratio or return on capital employed. The variousprofitability ratios have been given in the chart exhibiting the classification of ratios according totest. Generally, two types of profitability ratios are calculated(i) In relation to sales, and(ii) In relation to investments.Human Resource Accounting: Meaning, Definition, Objectives and Limi

The format of this statement is: 2. Fund Flow Statement: After preparing the schedule of changes in working capital, the next step is to prepare the Fund Flow Statement to find out the different sources and applications of funds. While preparing this . A projected cash flow statement is referred to as cash