Posted in Financial Accounting, Financial Management
on Feb 20th, 2014 | 0 comments
What is fund ?
Cash, total current assets, net current assets and net working capital are also interpreted as fund.
So, it is necessary to clearly define the meaning of fund and demarcate its scope and function. To put it precisely, fund is nothing but, net working capital of a firm.
The flow of fund occurs when a business transaction takes place that leads to an increase or decrease in the amount of fund.
Firms prepare fund flow statement to explain the sources and applications of fund, which also serves as a technical tool to ascertain the financial condition of a business enterprise.
In a business firm, everyday numerous financial transactions take place. These are summarized into a balance sheet that gives an idea about the assets and liabilities at a specific point of time.
When two balance sheets of consecutive periods are compared, we come to know about the inflow and outflow of funds and thereby the net working capital available is ascertained. This is step one.
Profit and Loss Statement
The next step would be to prepare an adjusted profit and loss account to determine fund inflow or fund lost from business operations.
Accounts have to be prepared to ascertain hidden information (for all non-current items of assets and liabilities). Finally fund lost or gained from operations is arrived at and presented in a statement form.
It is not that, only accountants could understand these operations and adjustments. Any person with logical reasoning and business acumen can understand the nuances of accounting, of course with some guidance.
Few points that highlight the ways in which funds flow outside and inside a business enterprise will give you a better idea on the nature of fund flow:
Sources of fund:
- Sale of fixed assets – sale of land, building, machinery, furniture etc. But you have to take into consideration a factor called “depreciation“.
- It is nothing but the wear and tear of the assets due to continuous usage, reduction in market value over a period of time, obsolescence, accidents etc. Remember, land is a non-depreciable asset in developing countries like India, whereas it may not be so in certain developed countries where the real estate values are nose diving.
- Issue of Equity shares – To raise capital free of interest, many big corporate firms go for equity capital from the general public.
- But the firms should make it a point to declare dividends if it happens to reap enormous profit to retain their market share. Their main aim should be to protect the interests of the equity share holders who are also the owners.
- Fund that comes into the firm through business operations – through sale of goods and services. Here the firm has to factorise its cost of production and economy of scale in order to make it cost-effective and fix a feasible profit margin.
- Borrowing of loans from banks and other financial institutions – Although it is a quick way of raising fund, care should be exercised in that, you should be in a comfortable position to “service the debt“.
- If not, there lurks the danger of bankruptcy where the firm might become insolvent, if it is unable to repay the interest and principal over a period of time.
- Issue of debentures – Debentures are also a form of equity but it comes with a price. The firm has to pay a percentage as interest on debentures and repayment period is also fixed in advance. The only solace for the firms would be the tax rebate that can be availed on loans and interests.