Test: Fund Flow Analysis - UGC NET MCQ

Fund flow analysis primarily focuses on monitoring the movement of funds within a company. This analysis is crucial for investors and analysts to understand how money moves in and out of a company over a specific period, helping them make informed investment decisions. By tracking the inflow and outflow of funds, investors can assess the financial stability and operational sustainability of a company.

One of the key objectives of Fund Flow Analysis is to identify financial trends and patterns. This analysis helps in revealing trends and patterns in cash flows and fund movements, aiding in budgeting, forecasting, and resource allocation. By analyzing historical data, it helps organizations identify cyclical patterns, seasonal variations, and long-term trends, providing valuable insights for financial planning and decision-making.

Fund flow analysis aids in evaluating an organization's financial health and solvency by monitoring the net movement of funds over time. This analysis provides insights into whether the organization is generating sufficient funds to cover expenses and meet financial obligations, which is crucial for maintaining liquidity and operational continuity.

Fund flow analysis can aid investors looking into a Real Estate Investment Trust (REIT) by revealing how money is managed within the REIT. This analysis provides insights into how much income the REIT generates from property rentals and how it utilizes this money, such as for property maintenance, repairs, or debt repayment. Understanding these financial aspects helps investors assess the performance and viability of investing in the REIT.

• The assertion is correct as fund flow analysis indeed relies on historical data, which may not effectively capture real-time financial conditions or future trends.
• The reason is also correct as economic changes, market fluctuations, and unforeseen events not being reflected in historical fund flow statements limits its predictive capability for future financial performance.
• However, the reason is not the correct explanation of the assertion because the assertion focuses on the limitations of fund flow analysis in capturing real-time and future financial conditions, while the reason elaborates on the factors that contribute to this limitation rather than explaining why it occurs.

This question tests the candidate's understanding of the limitations of fund flow analysis and the ability to differentiate between a statement and its underlying reasons.

Assertion: The assertion is correct. Fund flow analysis indeed plays a crucial role in evaluating a company's financial standing by examining the sources and uses of funds.

Reason: The reason is also true. Fund flow analysis helps in identifying the origins of funds and how they are expended within an organization.

Explanation: While both the assertion and reason are correct, the reason does not directly explain why fund flow analysis is a valuable tool. Fund flow analysis does but doesn't explain its significance in assessing a company's financial position.

• Assertion is correct as fund flow analysis can indeed help uncover financial irregularities and fraud.
• Reason is correct as discrepancies in fund flows can point towards unauthorized transactions, fund misappropriation, or operational inefficiencies.
• The Reason is the correct explanation of the Assertion because detecting discrepancies in fund flows is a key method for identifying potential financial irregularities and fraud within an organization.

- Assertion: The assertion is true. Fund flow analysis indeed relies on historical data, which may not offer real-time insights into current financial conditions.

- Reason: The reason is also true. Fund flow analysis might overlook recent developments or unforeseen events impacting an organization's current financial standing.

- Explanation: While both the assertion and reason are correct, the reason is not a direct explanation of the assertion. Fund flow analysis's focus on historical data doesn't directly imply it will miss recent developments or unforeseen events. Therefore, Option B is the correct answer.

The correct answer is (c) and (d) only
Key Points

•  A fund flow statement is a financial statement which is prepared to explain the reasons why the net working capital of a business changes by considering the inflows (sources of funds) and outflows (application of funds) for a particular year.
• This statement accounts for the reasons for changes in liabilities, assets and equity capital.
• Fund flow statement takes depreciation as an expense. Depreciation is regarded as a non-cash expenditure since it involves a reduction in the original value of an asset due to wear and tear.
• Depreciation can be considered of as the capital cost of an asset distributed over its life.

Important Points
Treatment of depreciation:

• As the amount of depreciation is debited from the profit and loss account of the firm, it is added back to operating profit to find fund from operations.
• Depreciation is just a process through which the costs are allocated. It is not counted/ considered as a source of fund because it is a non cash expenditure.
• But, depreciation leads to a reduction in the taxable income of the business since it is subtracted, so it can be considered as a source of fund in limited sense.

Hence, the correct answer is (c) and (d) only.

Net Profit: Net profit is the difference in total revenues and total expenses and losses which include both operating and non-operating items.

Funds From Operation: Funds from operation excludes both non-operating incomes and non-operating losses/expenses.
Non-operating income refers to the part of a company’s income that is not attributable to its core business operations. It is a category in a multi-step income statement. Dividend incomes, gains or losses from foreign exchange, as well as sales of assets, a write-down of assets, interest incomes, and expenses are all examples of non-operating income items.

Formula:
Fund from operation = Net Profit - Non-operating income(sale of the fixed asset)
= Rs. 44,000 - Rs. 4,000
= Rs. 40,000

Therefore, When net profit is Rs. 44,000 and profit on the sale of a fixed asset is Rs. 4,000, the fund from operations will be Rs. 40,000.