Contents :
- Sources of Funds.
- Uses or Applications of Funds.
What are The Sources of Funds ?
Business transactions, which result in an increase in working capital, are termed as "Sources of Funds". Issue of New Shares/Debentures, 'Raising of Loans', 'Depreciation on Fixed Assets', 'Profits', etc. are some of the examples of 'Sources of Funds'.
This has been presented in the figure below, which is followed by a detailed description of each item of Sources of Funds :
1) Funds from Operations/Operational Profit :
Profits generated out of the core operational activities of an organisation are regarded as one of the most important long-term sources of funds, as it (the net profit) increases the equity (before its partial distribution to owners in the form of dividends). As against this, the net loss incurred by an organisation decreases the equity. The investment in working capital is, therefore, enhanced/reduced as a result of 'Net Profit/Loss'. However, in an accrual accounting system, increase/decrease in 'Working Capital' does not necessarily tally with the stated 'Net Profit/Loss', due to the fact that certain expenses, which represent Non Current Amortisation are charged to the 'Profit & Loss Account'.
Further, Net Profit/Loss' needs to be adjusted in respect of the income or expenses which are not related to the core operation of the business activity. Such income/expenses are shown as separate items in the 'Funds Flow Statement'.
2) Issue of Shares :
The transaction relating to issue of shares for cash is a source of fund. However, a 'Non Current' liability is created by the inflow of funds. The net proceeds of the issue needs to be considered as a source of funds. In the case of shares issued at a 'Premium', the "Capital Amount' plus the amount of 'Share Premium' is considered as a 'Source of Funds' (the "Share Premium' being a 'Non Current Liability').
On the other hand, in a scenario wherein the shares are issued at a discount, the 'Capital Amount' minus the Discount Amount' is considered as a 'Source of Funds' (the 'Discount Amount' being a 'Non Current Assets'). In case of proprietorships or partnership firms, the amount of capital brought in during the year by the proprietor/partner, is considered as a 'Source of Funds'.
3) Issue of Debentures :
Debenture is a 'Non Current Liability' for the issuer. Its issue results in an increase in "Cash', which is a 'Current Asset'. However, this entire flow of funds is not considered as 'Source of Funds'; only the net proceeds need to be treated as the 'Source of Funds. 'Net Proceeds' are arrived at by including the amount of 'Debenture Premium' (if any), or excluding the amount of 'Debenture Discount' (if any).
4) Raising Long Term Loan :
Raising the 'Long Term Loans', like Deposits', 'Mortgage Loans etc. results in Inflow of Funds'. As there is increase in the availability of Working Capital', it is (Long Term Loans) considered as a 'Source of Funds'. In case of 'Short Term Loans', there is an Inflow of Funds', but it does not increase the availability of 'Working Capital', because of the fact that along with an increase in the. Current Asset' (Cash), there is an increase in 'Current Liability' also.
5) Sale of Fixed Assets :
In case of sale of any 'Fixed Asset' (non current asset), like Land, Building, Plant Machinery, Furniture, Fixture, etc. there is an inflow of funds, which is treated as a 'Source of Funds'. However, if one fixed asset is exchanged for another one, there is no inflow of funds and no current assets are involved and as such it is not considered as a 'Source of Funds'. If the sale is at a profit, the sale proceeds, whether Cash' or 'Credit', are treated as a 'Source of Funds'. In an event of an asset being discarded due to certain reasons, there is no 'Inflow of Funds'.
6) Non Trading Receipts :
Receipt of inflows of non-trading nature, e.g. Dividends, Tax Refund, Rental Income, etc. results in an increase in funds and as such needs to be considered as a 'Source of Funds'. Such an income is not a part of the income generated out of operational activities of an organisation.
7) Net Decrease in Working Capital :
The negative mismatch between the 'Sources of Funds' and 'Applications of Funds' results in the Net Decrease of the working capital. This may be illustrated by an example - if a business enterprise last year had working capital of Rs.1,00,000; in the current year the level of its "Sources of Funds' is a Rs. 5,00,000 and 'Applications of Funds Rs.5,25,000. It is clear that the 'Applications of Funds' have far exceeded the 'Sources of Funds. The business enterprise would be compelled to take an amount of Rs. 25,000 (the deficit amount) from last year's working capital, which will result reduction of its working capital.
Uses/Applications of Funds :
Application of funds is a part of the fund flow statement. It shows different applications (uses) of a organisation's working capital. Some examples of applications/uses of working capital are dividend payments to shareholders, purchase of new capital assets / equipment, payment of taxes, etc.
The funds may be used/applied in the following forms :
1) Funds Lost in Operations :
The result of business operations (manufacturing or trading) of an organisation during a year, at times, is a loss. Such a business loss is considered as an outflow or 'Application of Funds'.
2) Redemption of Preference Share Capital :
Redemption of preference shares during a year by an organisation is treated as 'Application of Funds', as it involves outflow of funds. Such redemption may be at par, at premium or at discount. In case of Preference Shares being redeemed at premium or discount, the net amount (including premium or excluding discount) of outflow is the 'Application of Funds'. However, if the redemption of preference shares takes place in exchange of some other type of instruments (shares or debentures), no outflow of funds is involved and as such there is no 'Application of Funds'.
3) Redemption of Debentures :
Redemption of Debentures is just like the redemption of Preference Shares, involving outflow of funds. The premium involved in the payment of redemption is also considered as a part of Application of Funds (as the premium on redemption is a 'Non Current Asset').
4) Repayment of Long-Term Loans : Repayment of :
i) Long-term loans raised from Financial Institutions'/"Banks'/'Others'.
ii) Funds raised through "Fixed Deposits by the business organisation, on maturity involves outflow of funds and should be treated as the 'Application/Use of Funds'
5) Purchase of Any Non-Current or Fixed Asset :
Purchase of a Fixed Asset or Non Current Asset like Land, Building, Plant, Machinery, Furniture, Fixture, Long Term Investments etc. involves an outflow of funds from the business and as such is treated as an 'Application of Funds'. However, if such 'Fixed Assets are acquired for a consideration like Issue of Shares or Debentures or it is exchanged for another, no outflow of funds from the business takes place and therefore, such cases of acquisition of 'Fixed Assets' are not considered as an 'Application of Funds'.
6) Payment of Tax and Dividends :
In case the Provision for Tax and 'Provision for Proposed Dividends' are treated as 'Non Current Liabilities, the 'Payment of Tax and Dividends' are considered as 'Application of Funds', as the 'Tax and Dividends' would be Non Current' items and their payments will lead to the reduction in Working Capital.
7) Any Other Non-Trading Payment :
A payment / expense unrelated to the core business operations of an organisation (e.g. 'Drawings' in case of a proprietorship or partnership firm, 'Loss of Cash', etc.) involves an 'Outflow of Funds' and as such is treated as an 'Application of Funds'.