Interpretation of funds flow statement

For the correct interpretation of the funds flow statement, the sources and application of funds can be categorized as below.

a.    Sources

i.    Long term sources – following types of sources may be treated as long term sources.

1.    Issue of shares/debentures.
2.    Long term borrowing of funds
3.    Operating
4.    Sale of fixed assets.

ii.    Short term sources – following types of sources may be treated as short term sources.

1.    Short term borrowing of funds.
2.    Increase in current liabilities.
3.    Decrease in current assets.

b.    Applications:

i.    Long term applications – following types of applications may be treated as long term applications.

1.    Purchases of fixed assets.
2.    Redemption of preferences shares/debentures.
3.    Repayment of long borrowings.

ii.    Short term applications – following types of application may be treated as short term applications.

1.    Increase in current assets.
2.    Decrease in current liabilities.
3.    Repayment of short term loans/deposits
4.    Dividends/taxes.

After categorizing the sources and applications as above, a proper interpretation of the funds flow statement can be carried out after keeping in mind the following propositions:

1.    Generally, long term sources of funds should be used for long term applications.
2.    Generally, short term sources of funds should be used for short term applications.
3.    In some cases, the long term sources of funds can be used for short term applications (e.g.
investment in core current assets), however under no circumstances short term sources of funds should be used for long term applications. If the short term sources of funds are used for long term applications, it results into diversion of funds. It indicates that the funds raised are not utilized for the purpose for which they are intended. It indicates that the funds which are repayable or adjustable in the immediate future, are applied for such purposes, the returns from which are not likely ti be received in the immediate future but are likely to be spread over a longer period of time. This indicates financial imprudency on the part of the organisation.