B Com Exam > B Com Notes > Financial Analysis and Reporting > Advantages and Limitations of Funds Flow Statement - Financial Analysis and Reporting
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Advantages of Funds Flow Statement:
Funds flow statement presents the following advantages:
(a) Fund Generating Capacity:
With the help of cash flows from operating activities, a Funds Flow Statement helps to understand the fund generating capacity of the firm which, ultimately, provides valuable information to the management for taking future courses of action.
(b) Changes in Working Capital Position:
A Funds Flow Statement presents either the increase in Working Capital or Decrease in Working Capital with the help of ‘A Statement of Exchanges in Working Capital’—which helps us to know from which sources the additional Capital has been procured, or the application of such funds.
(c) Projected Funds Flow Statement:
A firm can prepare its expected inflows and outflows of cash for future with the help of a Projected Funds Flow Statement.
(d) Highlights the Causes of Changes:
A Funds Flow statement highlights the significant causes of changes in Working Capital position between two accounting periods revealing the effect for the same on the liquidity and solvency position of a firm.
(e) Evaluation of Credit-Worthiness:
Credit Granting Agencies, after careful analysis of a Funds Flow Statement, can evaluate the creditworthiness of a firm—which helps them to understand the liquidity position.
Question for Advantages and Limitations of Funds Flow Statement - Financial Analysis and ReportingTry yourself: What is one advantage of a Funds Flow Statement?View Solution
(f) Highlight the Causes of the Following Contradictions:
(i) Adequate Cash Reserve but insufficient profit
Or
(ii) Sufficient profit, inadequate cash reserves.
Limitations of Funds Flow Statement:
The Funds Flow Statement is also not free from limitations.
(a) A funds flow statement cannot present a continuous change of financial activities including the changes of working capital.
(b) Since it is based on financial statement (i.e. Income Statement and Balance Sheet), it is not a original statement.
(c) A projected Funds Flow Statement does not always present very accurate estimates about the financial position since it is a historic one.
(d) It is not a substitute of financial statements, i.e. Income Statement and Balance Sheet. It simply supplies information about the change of Working Capital position which, again, depends on the data presented by the financial statements.
(e) Cash Flow Statement, i.e. changes in cash position, is more important or more informative than the changes in working capital which is presented by a Funds Flow Statement.
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FAQs on Advantages and Limitations of Funds Flow Statement - Financial Analysis and Reporting - Financial Analysis and Reporting - B Com
| 1. What is a funds flow statement and why is it important in financial analysis and reporting? |  |
Ans. A funds flow statement is a financial statement that shows the changes in a company's financial position by analyzing the inflow and outflow of funds during a specific period. It is important in financial analysis and reporting as it helps in understanding the sources and uses of funds, identifying the reasons for changes in a company's cash position, and evaluating its ability to generate and manage cash flows.
| 2. What are the advantages of using a funds flow statement in financial analysis? | |
Ans. The advantages of using a funds flow statement in financial analysis include:
- Helps in identifying the sources of funds: It provides information about the inflow of funds from various activities such as operating activities, borrowing, or sale of assets. This helps in understanding the financial health of the company and its ability to finance its operations.
- Highlights the uses of funds: It shows how funds are being utilized by the company, whether for operating expenses, capital expenditures, debt repayment, or dividend payments. This helps in evaluating the efficiency of resource allocation and the company's financial decisions.
- Assists in cash flow management: By analyzing the funds flow statement, companies can identify periods of cash surplus or deficit. This helps in planning and managing cash flows effectively, ensuring the availability of funds for operational needs and investment opportunities.
- Facilitates comparison over time: Funds flow statements can be prepared for multiple periods, allowing for a comparison of the changes in the company's financial position over time. This enables trend analysis and helps in assessing the financial performance and stability of the company.
- Provides supplementary information: In addition to the income statement and balance sheet, a funds flow statement provides supplementary information about the financial position and performance of the company. It enhances the understanding of the company's cash flow dynamics and helps in making informed financial decisions.
| 3. What are the limitations of funds flow statement in financial analysis? | |
Ans. The limitations of using a funds flow statement in financial analysis include:
- Limited focus on cash flows: While a funds flow statement provides information about the sources and uses of funds, it does not provide a detailed analysis of cash flows. It focuses more on the changes in working capital and long-term funds, and may not reflect the actual cash position of the company accurately.
- Historical nature: A funds flow statement is prepared based on historical data, which may not reflect the current or future financial position of the company. It may not capture the dynamic nature of cash flows and financial activities, limiting its usefulness in predicting future cash flows.
- Subjectivity in classification: The classification of funds into different categories in a funds flow statement involves subjective judgment. This can lead to variations in interpretation and may affect the comparability of funds flow statements prepared by different companies.
- Ignores non-cash transactions: A funds flow statement focuses on cash inflows and outflows, ignoring non-cash transactions such as depreciation, changes in market value of investments, or changes in working capital due to changes in inventory or accounts payable. This may result in an incomplete picture of the company's financial position.
- Reliance on historical cost: The funds flow statement is prepared based on historical cost, which may not reflect the current market value of assets and liabilities. This can affect the accuracy of the financial analysis and reporting.
| 4. How can a funds flow statement be used in financial analysis and reporting for decision-making? | |
Ans. A funds flow statement can be used in financial analysis and reporting for decision-making in the following ways:
- Assessing liquidity and solvency: By analyzing the sources and uses of funds, a funds flow statement helps in evaluating a company's liquidity position and its ability to meet short-term obligations. This information is crucial for making decisions regarding working capital management, debt repayment, or seeking additional financing.
- Evaluating investment opportunities: A funds flow statement provides insights into how funds are being utilized by the company, including investments in fixed assets or acquisitions. By assessing the impact of these investments on the company's cash flows, decision-makers can evaluate the potential returns and risks associated with different investment opportunities.
- Identifying financial constraints: By analyzing the funds flow statement, decision-makers can identify periods of cash shortage or excess. This helps in identifying financial constraints that may impact the company's ability to pursue growth opportunities, make dividend payments, or repay debts. It enables proactive decision-making to address these constraints and ensure the financial stability of the company.
- Monitoring financial performance: Funds flow statements can be prepared for multiple periods, allowing for the monitoring of changes in the company's financial position over time. Decision-makers can use this information to assess the financial performance of the company, identify trends, and make necessary adjustments to achieve financial objectives.
- Supporting strategic planning: A funds flow statement provides valuable information about the company's financial resources and how they are being utilized. This information can support strategic planning by helping decision-makers align financial resources with strategic goals, evaluate the financial feasibility of different strategies, and make informed decisions regarding resource allocation.
| 5. Are funds flow statements mandatory in financial analysis and reporting for B Com exams? | |
Ans. The inclusion of funds flow statements in financial analysis and reporting for B Com exams may vary depending on the specific curriculum or educational institution. While funds flow statements are an important tool in financial analysis, the focus of B Com exams may vary and may not specifically require the preparation or analysis of funds flow statements. It is advisable to consult the exam syllabus or guidelines provided by the educational institution to determine the specific requirements for financial analysis and reporting in B Com exams.
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