The technique of Funds Flow Analysis is widely used by the financial analyst, credit granting institutions and financial managers in performance of their jobs. It has become a useful tool in their analytical kit. This is because the financial statements, i.e., “Income Statement” and the “Balance Sheet” have a limited role to perform. Income statement measures flow restricted to transactions that pertain to rendering of goods or services to customers. The Balance Sheet is merely a static statement. It is a statement of assets and liabilities which does not focus major financial transactions which have been behind the balance sheet changes. One has to draw inferences after comparing the balance sheets of two periods. For example, if the fixed assets worth Rs. 2,00,000 are purchased during the current year by raising share capital of Rs. 2,00,000 the balance sheet will simply show a higher capital figure and higher fixed assets figure. In case, one compares the current year’s balance sheet with the previous year, then only one can draw an inference that fixed assets were acquired by raising share capital of Rs. 2,00,000. Similarly, certain important transaction which might occur during the course of the accounting year might not find any place in the balance sheet. For example, if a loan of Rs. 2,00,000 was raised and paid in the accounting year the Balance sheet will not depict this transaction. However, a financial analyst must know the purpose for which the loan was utilized and the source from which it was raised. This will help him in making a better estimate about the company’s financial position and policies.
The term “fund” generally refers to cash, to cash and cash equivalents, or to working capital. Of these the last definition of the term is by far the most common definition of “fund”.
There are also two concepts of working capital – gross and net concept. Gross working capital refers to the firm’s investment in current asset while the term net working capital means excess of current assets over current liabilities. It is in the latter sense in which the term ‘funds’ is generally used.