Chapter 18

Cash Flow Statements

Introduction
Funds flow statements used to be considered to be the third most important financial statement.
They contain no information additional to that found in the income statement and balance sheet.
Funds flow statements can be seen as a tool to aid in understanding the income statement and
balance sheet. The point of funds flow statements is that they attempt to highlight certain
information that is not immediately evident from the income statement and balance sheet. Funds
flow statements attempt to answer the following questions:

i. What did the company invest in during the year?

ii. Did the company repay any debts during the year? If so, how?
iii. How did the company finance new investments made during the year? Out of profits? by
borrowing? by issuing new shares?
iv. How did the mix of assets in the company change during the year?

Definition of funds as working capital

Funds flow statements therefore place more emphasis on a company's liquidity than its
profitability. There are several definitions of liquidity. One measure of liquidity is the working
capital of the business or its net current assets.

In order to understand a funds flow statement it is useful to start with the accounting equation:

Assets = Liabilities + Owners' Equity

(Equation 1)

Components of Equation 1 could be expanded into the following:

Fixed Assets + Current Assets = Long term Liabilities + Current Liabilities +

Owners' Equity + Profit.
(Equation 2)

Equation 2 can be re-arranged as follows:

2 Introductory Financial Accounting

Long term Liabilities + Owners Equity + Profit - Fixed Assets = Current Assets -
Current Liabilities
(Equation 3)

The funds flow statement explains changes in working capital (Current Assets minus Current
liabilities) through changes in items in equation 3. The new equation considering changes in each
of contents of Equation 3 can be depicted as follows:

Change in Long term Liabilities + Change in Owners' Equity + Profit/(Loss) for

the period - Change in Fixed Assets = Change in (Current Assets - Current
Liabilities)
(Equation 4).

What is gathered from the five terms of Equation 4 is that, there are four possible ways of
explaining changes in working capital of a company. These are:-

A] • Change in long term liabilities

If a company borrows long term, this is a source of funds, as it receives some cash. If
long term liabilities are repaid, this is a decrease in funds.

B] • change in owners' equity

If a company issues new shares, this is a source of funds, and if dividends are paid out to
owners, this is a use of funds.

C] • change in profit
Profitable operations are a source of funds and loss making operations deplete funds.
Depreciation, provisions and gains or losses on disposal of fixed assets do not count as
either sources or use of funds because they are just book-keeping entries and do not
involve changes in funds. These items are always adjusted when the Change in Profit is
established.

D] • change in fixed assets

If a company buys a new fixed asset, this is a use of funds; but if the company sells a
fixed asset, the proceeds from the asset sale are a source of funds.

E] • change in net current assets (current assets - current liabilities)

Change in these items equal to working capital which is the definition of funds.

Principal sources and uses of funds

In summary therefore, the principal sources of funds are as follows:
trading profit
injection of capital (such as share issues)
 Funds Flow Statements 3

borrowing (such as bonds and long term loans)

proceeds of sales of fixed assets

The principal uses of funds are as follows:

purchase of fixed assets
repayment of borrowing
withdrawal of capital (such as dividends)
tax payments
trading losses

Steps in preparing a funds flow statement

Refer page 407

Criticisms of the funds flow statement

The funds flow statement came under a lot of criticism. The major criticism was that there was
no clear definition of the term "fund" as set out in the accounting standards. Although working
capital was the most common definition, it was possible for companies to define funds
differently. Some companies took the term "funds" to mean cash rather than working capital.
This ambiguity in definition created a variety of accounting practices and confusion among users.

There also was no standard laid down format which every preparer had to conform to. As such
there were many ways one could present a funds flow statement.

Some quarters felt that the funds flow concept obscured the cash position of a company by
incorporating this item within other elements of working capital. Prominence of the cash position
was thought to be important in fulfilling one fundamental objective of users, i.e. identifying
future cash flows of a business.

These criticisms led to the fundamental review of the accounting standard for funds flow
statements. Eventually, the funds flow statement gave way to the cash flow statement.

The cash flow statement

Introduction
Tanzania Financial Accounting Standards [TFAS] require companies to publish a cash flow
statement as part of annual financial statements. The purpose of this statement is to reveal to
users how cash was generated and then how it was used by the company during the period under
review. The cash flow statement should be useful to users in a number of ways. It should, for
example, help in assessing:
4 Introductory Financial Accounting

the ability of the business to generate future cash flows

the effect of major events such as a share issue or acquiring another business on the liquidity of
the business
the ability of the business to meet future commitments such as loan repayments, interest
payments, taxation due, etc
likely future financing needs.

Definition of cash
In order to prepare a cash flow statement in accordance with TFAS, it is necessary to understand
how the term "cash" is defined. The term will include cash in hand and cash on deposit with a
bank or other financial institution. However, it will also include "cash equivalents" which are
short-term liquid investments. "Cash equivalents are investments which can be converted into
cash without notice and which are within three months of maturity when acquired. Short-term
advances from banks, which are repayable within three months of the date of advance, must be
deducted from the total cash and cash equivalents in order to derive the net cash balance.

This rather broad definition of cash has been used because it was felt that it would provide a
clearer picture of how cash is managed during the period. If a narrow definition of cash is used,
the true liquidity position of the business could be obscured. For example, a business may have a
relatively small amount of cash in hand or in the bank at any given time. However, this may be
due to the fact that any spare cash available is channeled into short-term investments in order to
generate additional revenues for the business.

Preparing the cash flow statement

TFAS lay down a format for the cash flow statement which identifies separately the main
activities resulting in cash inflows or outflows. The standard requires that five separate categories
of cash flow should normally be shown on the face of the cash flow statement. These are:

A] Operating activities, that is the net cash flows which have been generated from trading
operations during the period.

B] Returns on investments and servicing of finance, that is interest received and paid and
dividends received and paid during the period.

C] Taxation, which is corporation tax payments and any tax rebates or refunds of overpayment.

D] Investing activities, which are proceeds from the sale of fixed assets and investments in
other entities. Payments to acquire fixed assets and investments in other entities will also be
included

E] Financing activities, which is receipts from the issue of shares, loans and debentures.
Payments to redeem shares of the company and repayments of amounts borrowed will be
shown. Also included are any expenses incurred in the issue of shares, loans or debentures.
 Funds Flow Statements 5

Not only does the guideline require that each of these categories be separately identified (unless
there are no material cash flows to be reported under them) but also the categories must be shown
on the cash flow statement in the stipulated order.

The cash flow statement format in detail

Having explained the various types of cash flow that need to be reported, we can now examine a
cash flow statement which has been prepared in accordance with the standard. Note that the
heading shown in bold are necessary to comply with the guideline.

Mt.Arafa Ltd
Cash flow Statement for the Year Ended 30 June 19X6
Net cash inflow from operating activities 10,000
Returns on investments and servicing of Finance:
Interest received
2,000
Interest paid (3,000)
Dividends paid (4,000)
Net cash inflow(outflow) from returns on investments and servicing
of finance (5,000)
Taxation
Corporation tax paid (3,200)
Tax paid (3,200)
Investing activities:
Payments to acquire intangible fixed assets (200)
Payments to acquire tangible fixed assets (1,200)
Receipts from sales of tangible fixed assets 300
Net Cash inflow/(outflow) from investing activities (1,100)
Net cash inflow before financing 700
Financing Activities:
Issue of ordinary capital 2,000
Repurchase of debenture loan (1,000)
Expenses paid in connection with share issue (100)
Net cash inflow/(outflow) from financing 900
Increase/(decrease) in cash and cash equivalents 1,600

Calculating cash flows

In order to prepare a cash flow statement we must be clear about how to calculate or derive the
figures to be shown on the statement. In this section we will consider each of the categories of
cash flow in turn to see how the amounts to be shown are determined.
6 Introductory Financial Accounting

Net cash flows from operating activities

There are two approaches, which can be used to determine this figure - the direct method and the
indirect method. TSAG 8 allows companies to calculate the net cash flows from operating
activities using either method. The choice of method is not of critical importance as the same
figure for net cash flows should be derived whichever method is adopted.

The direct method

This method arrives at the required figure by employing information contained within the
accounting records of the company. These records can be used to identify cash movements
relating to operating activities. The relevant cash movements will include cash sales, cash
received from trade debtors, cash purchases, cash paid to trade creditors and suppliers as well as
other cash expenses. To calculate the net cash flows from operating activities the following
calculation must be performed:

Cash sales X
Cash received from debtors X
X
Less:
Cash purchases X
Cash paid to trade creditors and suppliers X
Cash expenses X X
Net cash flow from operating activities X

The indirect method

This method does not rely on the underlying accounting records to derive the net cash flows from
operating activities. Instead, the information contained in the profit and loss account and balance
sheet is used. The 'net profit before taxation figure in the income statement provides the starting
point for calculations. By making certain adjustments to the net profit before taxation figure, it is
possible to derive the net cash flows from operating activities.

Depreciation and profits and losses on the disposal of fixed assets may be included in the profit
and loss account of a business but will not involve movements of cash. These items are simply
book entries and so it will be necessary to adjust for them in order to derive the net cash flow
operations. (The cash proceeds on disposal of a fixed asset will, of course, result in a cash inflow;
however, this inflow is dealt with in another part of the cash flow statement).

Movements in the level of stocks, debtors and creditors must also be taken into account. A
decrease in stocks or debtors will increase the cash generated from operating activities, whereas a
decrease in creditors will reduce cash. Similarly, an increase in stock will effectively decrease the
cash available to the business.
 Funds Flow Statements 7

Interest payable and receivable may also appear in the profit and loss account of a business.
Although these items may well result in cash movements during the period (depending on the
timing of interest payments and receipts), they must nevertheless be adjusted for in deriving the
net cash flow from operating activities. This is because these items will be dealt with elsewhere
in the cash flow statement.

The above items would be taken into account in order to deduce the net cash flows from
operating activities as follows:

Net profit before taxation X

Add back:
Depreciation of fixed assets X
Loss on sale of fixed assets X
Interest payable X X
X
Deduct:
Profit on sale of fixed assets X
Interest receivable X X
X
(Increase)decrease in stock X
(Increase)decrease in debtors (X)
Increase/(decrease)in creditors (X) (X)
Net cash flow from operating activities (X)

It is important that you understand both of the methods described above as you may be required
to calculate net cash flows from operating activities using either or the methods.

Using the information contained in illustrative problem on page 409 we can calculate the net cash
flows from operating activities as follows:

T.Shs 000s T.Shs 000s

Net profit before taxation 1500
Add back:
Loss on sale of fixed assets 10
Depreciation of fixed assets 140
Interest payable - 150
1650
Deduct:
Interest receivable -
1650
(Increase)/decrease in stock 230
(Increase)/decrease in debtors (80)
Increase(decrease) in creditors (150)
Increase(decrease) in Rent Payable (80)
Increase(decrease) in Wages Payable 30
8 Introductory Financial Accounting

(50)
1600

Returns on investments and servicing of finance

We have seen earlier that this includes interest received and paid during the period and dividends
paid. The dividends shown in the cash flow statement should be the dividends actually paid
during the period. There is a lag between the proposal of dividends and their payment. Dividends
paid in one year usually relate to dividends proposed in another year. The only exception to this
arises where interim dividends are paid. These are both an appropriation of profits and an outflow
of cash.

For example, the dividend to be shown on the cash flow statement for the year ended 31
December 19X9 will be the amount shown as a current liability in the balance sheet as at 31
December 19X8, since that dividend will be paid in the following year. The illustrative problem
simplified matters and assumed dividends were declared and paid during the year of reporting.

Taxation

The cash flow statement should reflect the corporation tax actually paid. Since corporation tax is
typically paid some months after the financial year-end, it is reasonable to assume that the tax
provided in the profit and loss account will not be paid until the next year. This provision will
appear in the balance sheet as a current liability. Again the illustrative problem simplified matters
and assumed income tax was assessed and paid during the year of reporting.

Investing activities

Changes in fixed assets over a period can arise in a number of ways, namely:

 depreciation of assets - a decrease

 purchase of new assets - an increase
 sale of existing assets - a decrease

We have seen earlier that depreciation of fixed assets will appear as an adjustment in arriving at
'net cash flows from operating activities' together with any profit or loss on disposal. The
purchase of fixed assets and the proceeds from the sale of fixed assets are shown under the
heading of investing activities'.

Financing activities

We have seen earlier that this section will include the receipts from the issue of shares, loans and
debentures, as well as payments to reacquire or redeem shares of the company and repayments of
any amounts borrowed. Also included are any expenses incurred in the issue of shares, loans or
debentures.
 Funds Flow Statements 9

It is worth mentioning that an increase in shares attributable to a bonus issue will not be shown
on the cash flow statement, since it is only a transfer from reserves to capital, and not an issue of
shares for cash. In some cases, shares will be issued at a premium. A comparison of the opening
and closing balances on the share premium account will ascertain whether this is so. When shares
are issued at a premium the cash flow statement will reflect the total cash generated by the issue
(that is, the par value of shares issued plus any premium).

Now that we have considered the way in which the various figures that appear on the cash flow
statement are derived it is possible to prepare a cash flow statement for Maendeleo Company Ltd.

Maendeleo Company Ltd

Cash flow Statement for the Year Ended 31st December 1991
T.Shs 000s T.Shs 000s
Net cash inflow from operating activities 1,600
Returns on investments and servicing of Finance:
Interest received 0
Interest paid (0)
Dividends paid (800)
Net cash inflow(outflow) from returns on investments and servicing
of finance (800)
Taxation
Corporation tax paid (300)
Tax paid (300)
Investing activities:
Payments to acquire intangible fixed assets (0)
Payments to acquire tangible fixed assets (250)
Receipts from sales of tangible fixed assets 50
Net Cash inflow/(outflow) from investing activities
(200)
Net cash inflow before financing 300
Financing Activities:
Issue of ordinary capital 0
Redemption of Bonds (100)
Expenses paid in connection with share issue (0)
Net cash inflow/(outflow) from financing (100)
Increase/(decrease) in cash and cash equivalents 200

Analysis of changes in cash and cash equivalents during the year

Balance as at 1st January, 1990 900
Net Cash Inflow during the year 200
Balance as at 31st December, 1991 1,100

Introduction

In previous chapters, preparation of financial statements for various organizations have been
10 Introductory Financial Accounting

illustrated. These mainly consist of the Balance Sheet and the Income Statement or Profit and
Loss Account. Although each of these financial statements contains useful information related to
the financial position of the business enterprise and the results of its operation, they do not show
how the business has financed its business activities, nor the various sources of funds for these
activities.

TSSAP 2 requires certain business entities to prepare another financial statement which provides
this additional information. This is the Statement of Source and Application of Funds also called
Statement of Changes in Financial Position or Funds Flow Statement. As the name indicates this
statement shows the inflow and outflow of funds in the business.

The concept of funds

All business entities are engaged in various financing and investing activities. As they do so, they
generate and use funds. The term funds has different meanings. To some, funds consist of cash
and cash equivalents, whereas to others, funds are the working capital of the business firm.

In Tanzania, the Statement of Source and Application of Funds is often prepared using the concept
of funds as working capital, that is, current assets less current liabilities. Using this concept,
transactions that increase working capital are source of funds and transactions that decrease
working capital are applications of funds. The amount of working capital will increase or decrease
as a result of transactions that affect both current and non-current accounts.

For example, when equipment is bought on credit, it will result in a decrease in working capital.
This is due to the increase in current liability (credit to supplier). This decrease in working capital
may be viewed as a use of funds, in this case, for buying the fixed asset.

Sources of working capital

The most common sources of funds are the following:

(a)Current business operations. - This is an important source of the firm's working capital. The
revenue and expense transactions of the firm ordinarily result in the profit or loss reported in the
Income Statement. This net profit or income may be considered the net source of funds provided
by operations. There are however expense items which do not involve movement of funds so they
do not affect working capital e.g. depreciation and amortization of fixed assets. Therefore, these
items should be shown as adjustments of net income to arrive at the funds resulting from business
operations. This will be illustrated later in the chapter.

(b)Long-term borrowing - The issuance of bonds or long-term notes is a common source of

working capital. The actual funds provided through a bond issue would be the face value of the
bond plus the premium or minus the discount, if any.

(c)Sale of non-current assets - The sale of long-term investments and other fixed assets for cash or
on credit provides working capital for the business. The actual funds provided by these
transactions would be the net proceeds from the sale.

(d)Additional Capital provided by the owners - In case of companies, this is done through issue of
shares. The increase in working capital would be the actual amount received, that is, including the
premium if any.
 Funds Flow Statements 11

Uses of working capital

The use of working capital represents applications or outflow of funds from the business. The
common uses of funds are the following:

(a)Purchases of non-current assets - Funds may be used for buying fixed assets or long-term
investments like bonds or shares in companies. The actual amount paid for these non-current
assets will represent application of funds.

(b)Payment of long-term liabilities - The liquidation of bonds payable or long-term notes

represents an application of funds to the extent of the actual amount paid.
(c)Withdrawal of capital - In a single proprietorship or partnership, this will be the drawings made
by the owner or partners in terms of cash or other current assets. In companies, cash may be used
to redeem certain class of shares. This topic is treated in advanced accounting course.

(d)Payment of dividends - In companies, when dividends are paid, this amount represents an
application of funds. International Accounting Standards accept as an option treatment of declared
dividends as an application of funds.

Steps in preparing statement of source and application of funds

As stated earlier, a Statement of Source and Application of funds is essentially an analysis of the
changes in the financial position of the business entity during an accounting period. This period
encompasses two balance sheet dates. Indirectly, the Income Statement of that period is also
analysed to account for the change in Retained Earnings or Profit and Loss account. A Statement
of Source and Application of Funds has three sections presented in a vertical format. The first
section shows the sources of funds, the second section the application of funds. The third section
explains the net difference between the first and second sections.

The analysis of financial statements and preparation of the Statement of Source and Application of
Funds consist of the following steps:

(a)Comparison of two successive balance sheets of the firm, and accounting for the increase or
decrease in all non-current items in both assets and liabilities. For example, the balance sheets for
year 1 and year 2 may show the following balances for Fixed Assets:

Year 1 Year 2 Increase

(Decrease)

Motor Vehicles 900,000 300,000 (600,000)

Office Equipment 400,000 750,000 350,000

Initially, it may be assumed that the shs. 600,000 decrease in Motor Vehicles represent a sale of
fixed asset and therefore a source of fund. On the other hand, the increase of shs. 350,000 in
office Equipment may be assumed to be a purchase of fixed asset and therefore an applications of
fund. A more thorough analysis is needed of each account to be able to identify the components of
the transactions which gave rise to the increase or decrease in a fixed asset. Workings showing
details of the change will have to be prepared.

(b)The net income or profit before tax from the Income Statement is adjusted for items which do
not represent flow of funds, e.g. non-cash items like depreciation, provision for doubtful debts,
etc. Since these items are expenses which have reduced the net income, the adjustments would
show them as additions. For example, if Net Income for Year 2 is shs. 235,000 and during the
year provisions were made for depreciation of shs.
12 Introductory Financial Accounting

80,000 and for doubtful debts of shs. 15,000 these will be shown as follows:

Net Income from operations Shs. 235,000

Add: Depreciation expense 80,000
Doubtful Debts expense 15,000
Total funds provided from operations Shs. 330,000

(c)All sources of funds should be listed on the first section of the Statement.

(d)All applications of funds should be listed on the second section of the Statement, and the total
applications deducted from the total sources to arrive at the net increase or decrease of funds
during the period.

(e)Account for the increase or decrease in working capital by analysing the changes in the current
assets and current liabilities between Year 1 and year 2 as shown in the balance sheets. An
increase in working capital results from an increase in current asset or a decrease in current
liability. A decrease in working capital results from a decrease in current asset or an increase in
current liability.

For example, the balance sheet (extracts) shows the following items:

Year 1 Year 2 Increase

(Decrease)
Shs. Shs. Shs.
Stocks 460,000 570,000 110,000
Debtors 370,000 280,000 ( 90,000)
Creditors 540,000 420,000 (120,000)

The above changes may be summarized as follows:

Increase in Working Capital due to:

Increase in Stocks 110,000

Decrease in Creditors 120,000
Total increase in Working Capital 230,000

Decrease in Working Capital due to:

Decrease in Debtors 90,000

Net increase in Working Capital 140,000

(f)The summary of the increase/decrease in working capital is set forth in the third section of the
Statement of Source and Application of Funds.

(g)The net increase or decrease in working capital should equal the net increase or decrease in
funds that are shown in the second section of the Statement.

Illustrative Problem:

Balance Sheet

31/12/90 31/12/91
 Funds Flow Statements 13

Shs. Shs.

Cash 900,000 1,100,000

Trade Debtors 720,000 800,000
Inventory 980,000 750,000
Total Current Assets 2,600,000 2,650,000
Leasehold Premises 2,300,000 2,300,000
Furniture and Equipment 3,300,000 3,400,000
Less: Accumulated Depreciation ( 900,000) ( 950,000)
Total fixed assets 4,700,000 4,750,000
Total Assets 7,300,000 7,400,000
Trade Creditors 1,100,000 950,000
Wages Payable 200,000 230,000
Rent Payable 250,000 170,000
Total Current Liabilities 1,550,000 1,350,000

Bonds Payable 1,400,000 1,300,000

Share capital 2,400,000 2,400,000
Retained Earnings 1,950,000 2,350,000
Total Long-term Liabilities
and Equity 5,750,000 6,050,000
Total Equities 7,300,000 7,400,000

Maendeleo Company
Income Statement
For the Year Ended 31December, 1991

Shs.

Net Sales 9,500,000

Less: Cost of Goods sold 4,900,000
Gross profit 4,600,000
Less: Operating Expenses 3,090,000
Net profit 1,510,000
Less: Loss on Equipment sold 10,000
Income before Taxes 1,500,000
Less: Income Tax Expense 300,000
Net Income after tax 1,200,000

Additional information:

(a)Operating expenses included the annual depreciation of furniture and equipment.

(b)Dividends were declared and, paid during the year.

(c)Equipment with a cost of shs. 150,000 and accumulated depreciation of shs. 90,000 was sold
during the year at a loss of shs. 10,000.
(d)Income tax was assessed and paid during 1991.

Required:

Prepare in good format a Statement of Source and Application of Funds for the year ended 31
December, 1991.
14 Introductory Financial Accounting

The Statement of Source and Application of Funds may be prepared following the steps given in
the previous section as follows:

(a)Make a comparison of non-current items as shown below:

1990 1991 Increase

(Decrease)
Leasehold Premises 2,300,000 2,300,000 -
Furniture & Equipment 3,300,000 3,400,000 100,000
Accum. Depr. ( 900,000) ( 950,000) 50,000
Bonds Payable 1,400,000 1,300,000 (100,000)
Share Capital 2,400,000 2,400,000 -
Retained Earnings 1,950,000 2,350,000 400,000

Using the additional information, workings could be prepared showing the components of the
above changes in non-current items.

Workings:
(i) Furniture and Equipment
31/12/90 Balance b/d 3,300,000│1991 Disposal a/c 150,000
1991 - Additions │
(balancing item) 250,000│31/12/91 Balance c/d 3,400,000
3,550,000│ 3,550,000

Note:The additions of shs. 250,000 which is a purchase of new fixed asset is an application of
funds.

(ii)Accumulated Depreciation
1991 - Disposal a/c 90,000│31/12/90 Balance b/d 900,000
31/12/91 Balance c/d 950,000│1991 - Depreciation
│ (balancing item) 140,000
1,040,000│ 1,040,000

Note: Shs. 140,000 is the annual depreciation which has been included in operating expenses.

(iii) Equipment Disposal Account

1991 - Furniture & │1991 - Accum. Depr. 90,000
Equipment (cost) 150,000│ Loss on Sale 10,000
│ Cash (proceeds
│ balancing item) 50,000
150,000│ 150,000
Note: The cash proceeds of shs. 50,000 from the sale of equipment is a source of funds.
(iv) Retained Earnings
1991 - Dividends paid │31/12/90 Balance b/f 1,950,000
(balancing item) 800,000│1991 - Net Income 1,200,000
31/12/91 Balance c/f 2,350,000│
3,150,000│ 3,150,000
Note: The dividends paid of shs. 800,000 is an application of funds.

There is no additional information regarding Bonds Payable, so it may be assumed that the
 Funds Flow Statements 15

decrease of shs. 100,000 was payment for bonds which have matured. This is an application of
funds.

(b)The Net Income before tax will be adjusted for items not representing flow of funds which are:

(i)Depreciation Expense of shs. 140,000 (per workings) should be added back to net income as it
has been included in the Operating Expenses that were deducted from Gross profit.

(ii)Loss on Sale of Equipment of shs. 10,000 should be added back to net income, since only the
cash proceeds from the sale of shs. 50,000 (per workings) would be considered as source of funds.
This loss does not represent a flow of funds.

(c)The first section of the Statement could be prepared showing all the sources of funds which are;
the Net Income before tax after adjustments and the cash proceeds from the sale of equipment.

(d)The second section of the Statement would contain the following application of funds:

(i) Purchase of Furniture and Equipment (per workings)

(ii) Dividends paid (per workings)
(iii) Payment of Bonds payable
(vi) Payment of tax

(e)Make an analysis of changes in current assets and current liabilities as shown below:

Current assets: 1990 1991 Increase

(Decrease)

Cash 900,000 1,100,000 200,000

Trade Debtors 720,000 800,000 80,000
Inventory 980,000 750,000 (230,000)

Current Liabilities:

Trade creditors 1,100,000 950,000 (150,000)

Wages payable 200,000 230,000 30,000
Rent payable 250,000 170,000 ( 80,000)

(f)The summary of the above increases and decreases in current assets and current liabilities will
be presented in the third section of the Statement.

The completed statement is shown below:

Maendeleo Company
Statement of Source and Application of Funds
For the year ended 31 December 1991

Shs. Shs.

Sources of funds:
From Operations -
Net Income before tax 1,500,000
Add: Depreciation 140,000
Loss on Equip. sold 10,000
16 Introductory Financial Accounting

Funds provided from operations 1,650,000

Sale of Equipment (proceeds) 50,000
Total sources 1,700,000

Application of Funds:

Purchase of Furniture & Equip. 250,000

Payment of Bonds Payable 100,000
Dividends paid 800,000
Tax paid 300,000 1,450,000
Net Increase in funds 250,000
Increase in Working capital due to:
Increase in Cash 200,000
Increase in Trade Debtors 80,000
Decrease in Trade Creditors 150,000
Decrease in Rent payable 80,000
Total increase in Working Capital 510,000

Decrease in Working Capital due to:

Decrease in Inventory 230,000
Increase in Wages Payable 30,000
Total decrease in
Working Capital 260,000
Net Increase in Working Capital 250,000

The above statement has been presented using the format which is the one commonly used in
Tanzania.

Cash flow statement

When the term funds is used to refer to cash (on Hand and in Bank), the Statement of Source and
Application of funds will show the changes in all the current and non-current items during an
accounting period as either a source of cash (inflow) or an application of cash (outflow). In effect
it becomes a cash flow statement.

This is illustrated below using the previous example.

Maendeleo Company
Statement of Source and Application of Funds
For the year ended 31 December, 1991

Shs. Shs.

Sources of Funds:
From Operations;
Net Income before tax 1,500,000
Add: Depreciation 140,000
Loss on Equipment sold 10,000
Funds provided from operations 1,650,000
Sale of Equipment (proceeds) 50,000
Total sources 1,700,000

Applications of funds:
 Funds Flow Statements 17

Purchase of Furniture & Equip. 250,000

Payment of Bonds payable 100,000
Dividends paid 800,000
Tax paid 300,000
Increase in Trade Debtors 80,000
Decrease in Trade Creditors 150,000
Decrease in Rent Payable 80,000
Decrease in Inventory (230,000)
Increase in Wages Payable ( 30,000) 1,500,000
Net increase in funds 200,000
Cash 31/12/90 900,000
Cash 31/12/91 1,100,000
Net increase in cash 200,000
18 Introductory Financial Accounting

Review questions

1.What are the different meanings of "funds"?

2.What are the different sources of funds?

3.What are the different uses of funds?

4.Why is it important to prepare a Statement of Source and Application of funds?

5.When computing the source of funds from business operations what items are added to or
subtracted from net income? Explain why.

6.Describe in sequence the steps required to prepare a Statement of Source and Application of
Funds.

7.What is the relationship between the net increase/decrease in funds and the net increase/decrease
in working capital?

8.Describe the format of the Statement of Source and Application of Funds based on the working
capital concept of fund.

9.What is a cash flow statement?

10.What is the difference between a cash flow statement and a funds flow statement?

11.Explain why a decrease in current liability represents an increase in working capital.

12.Why are the changes in non-current items analyzed to discover changes in working capital?

13.The ordinary purchases of goods has no effect on working capital" Is this true? Why?

14."Depreciation is a source of working capital." Do you agree? Explain.

15.Why is it necessary to analyse the changes in the components of working capital?

 Funds Flow Statements 19

Exercises
1.Is it possible for a business firm to have a net loss for the year and yet show an amount for cash
or working capital provided by operations? Support your answer with an example.

2.What is the effect on Working Capital of the following transactions:

(a)Issued a five year note payable in the amount of shs. 500,000.

(b)Sold a typewriter (book value shs. 17,500) for shs. 20,000 cash.
(c)Provided depreciation of shs. 35,000 on all fixed assets.
(d)Purchased a new computer terminal for shs. 800,000
(e)Sold and issued 1,000 preference shares of shs. 100 at shs. 115 per share.
(f)Declared cash dividends totaling shs. 250,000.
(g)Payment to Trade creditors of shs. 20,000.
(h)Purchases of goods amounting to shs. 36,000.
(i)Repayment of bond payable shs. 400,000 plus interest of shs. 16,000.
(j)Collection of shs. 90,000 from Trade Debtors.

3.From the following balance sheet extracts, prepare a schedule to show the amount of cash
provided by business operations.

Year 5 Year 4
Shs. '000 Shs. '000
Assets:
Cash 60,000 50,000
Trade Debtors 110,000 100,000
Inventory 180,000 200,000
Total 350,000 350,000
Liabilities and shareholders
Equity:
Trade creditors 30,000 40,000
Wages payable 30,000 60,000
Share capital 110,000 100,000
Retained Earnings 180,000 150,000
Total 350,000 350,000

Note: Cash Dividends of shs. 1,000,000 paid during year 5.

4.The following data were taken from the comparative balance sheet of Geu-Geu Corporation.
19X2 19X1
Shs.'000 Shs. '000
Cash 2,000 1,600
Trade Debtors 3,500 3,800
Inventory 5,000 5,200
Prepaid Rent 500 400
Equipment 9,000 7,000
Motor Vehicles 1,500 1,000
Total Assets 21,500 19,000
Trade creditors 3,600 4,000
Taxes Payable 200 100
Salaries payable 100 100
Bonds payable 5,000 5,000
Share capital 8,200 8,200
Retained Earnings 4,400 1,600
20 Introductory Financial Accounting

Total Equities 21,500 19,000

Required:

Prepare a schedule of changes in working capital components for the year ended 31 December,
19X2..

Problems
1.The directors of Muddle Ltd have presented you with the following summarised final accounts:

Balance sheet
31 Oct. -5 31 Oct. -6
Shs. 000 Shs. 000

Ordinary share capital (shs 1 per share) 740 940

Revenue reserves 531 864
Share premium account - 100
Loans 320 150
Trade creditors 152 141
Proposed dividends 140 170
Current taxation 470 602
Bank overdraft - 766
2,353 3,733

Shs.'000 Shs.'000
Plant and machinery
- cost 2,700 3,831
- accumulated depreciation 748 1,125
1,952 2,706
Stock 203 843
Debtors 147 184
Cash at bank 51 -
2,353 3,733

Profit and loss account

for the year ended 31 Oct. 19-6

Shs.000 Shs.000
Profit before tax 1,195
Corporation tax 602
Profit after tax 593
Ordinary dividends - paid 90
- proposed 170
260
Retained profit 333
You further ascertained that:

(a)The only new loan raised during the year was a five year bank loan amounting to shs. 65,000.

(b)Depreciation charged during the year amounted to shs. 401,000.

(c)During the year, plant which originally cost shs. 69,000 was disposed of for proceeds of shs.
 Funds Flow Statements 21

41,000.

Required:

Prepare a Statement of Source and Application of Funds for the year ended 31 October, 19-6.

2.The following are the summarised balance sheets of Bongo Ltd as at 31 Dec.:

19-5 19-6
Shs. Shs. Shs. Shs.
Fixed assets
Tangible assets
- Cost 240,070 253,730
- depreciation 90,020 98,480
150,050 155,250
Investments
(unquoted) 61,000 76,000
211,050 231,250
Current assets
Stock 98,000 104,000
Debtors 88,000 85,000
Cash 11,750 32,000
197,750 221,000
Creditors: amounts
falling due within one year
Bank loan 22,000 -
Creditors and
accruals 84,450 75,550
106,450 75,550
Net current assets 91,300 145,450
Total assets less
current liabilities 302,350 376,700
Creditors: amounts
falling due after
more than one
year
6½% debentures - 40,000
302,350 336,700
Capital and reserves
Called up share capital
- Sh. 1 ordinary shares 75,000 100,000
- 6% preference shares 100,000 100,000
General reserve 15,000 15,000
Profit and loss account 112,350 121,700
302,350 336,700

Additional information:

(a)Depreciation of fixed assets of shs. 13,000 was charged to profit and loss account.

(b)Equipment with a cost of shs. 6,000 and accumulated depreciation of shs. 4,800 was sold for
shs. 250 and the loss written off to profit and loss account.
22 Introductory Financial Accounting

(c)The preference dividend was paid on 31 December each year. No ordinary dividend has been
proposed or paid in 19-5 or 19-6.

Required: Prepare a Statement of Source and Application of Funds during 19-6.

3.The comparative financial statements of Mabait Company Ltd. are shown below:

Balance Sheets
as at 30 June 1991 and 1992

1992 1991
Shs. '000 Shs. '000
Current Assets:
Cash 6,000 5,000
Trade Debtors 10,000 12,000
Inventory 18,000 15,000
Total Current Assets 34,000 32,000

Plant & Equipment 30,000 25,000

Less: Accum. Depreciation 13,000 11,000
Net Book Value 17,000 14,000

Bond Investment 9,000 10,000

Total Assets 60,000 56,000
Current Liabilities:
Trade Creditors 16,000 10,000
Accrued Expenses 4,000 5,000

Total Current Liabilities 20,000 15,000

Bonds Payables 7,000 14,000

Shareholders' Equity:
Shs. 100 Ordinary Shares 15,000 13,000
Retained Earnings 18,000 14,000

Total Shareholders' Equity 33,000 27,000

Total Liabilities & Shareholders
Equity 60,000 56,000

Mabait Company Ltd.

Income Statement
For the Year Ended 30 June, 1992

Shs.'000
Sales 132,000
Cost of Goods Sold 98,000
Gross Margin 34,000
Operating Expenses 21,000
Net Operating Income 13,000
Less: Interest 2,000
Net Income after Interest 11,000
Less: Income Tax 3,000
Net Income after Tax 8,000
 Funds Flow Statements 23

Additional information:
(1)Equipment with cost of shs. 2,000,000 and Accumulated Depreciation of shs. 1,200,000 was
sold for shs. 800,000.

(2)The Operating Expenses included the annual depreciation on Plant & Equipment.

(3)The Company declared and paid dividends of shs. 4,000,000 in 1992.

Required:

(a)Prepare in good format a Statement of Source and Application of Funds.

4.The following are the Balance Sheets of Nyanza Textile Manufacturers Ltd. on the dates as
indicated thereon:-

31December, 1984 31December, 1985

shs. '000 shs. '000
Paid up share capital
@ shs. 1 ordinary share 800 1,300
@ shs. 1 6% pref. shares 200 200
Share premium 290 390
Reserves 640 540
Profit and Loss Account 320 448
8% Redeemable debentures 250 90
Creditors 406 452
Bills payable 298 346
Corporation tax due within
next year 68 236
Proposed dividends 92 52
3,364 4,054

Shs.'000 Shs.'000
Buildings at valuation 770 1,014
Plant and machinery, net 884 1,146
Motor Vehicles, net 136 158
Furniture 62 84
Investments, at cost
- all quoted 314 208
Stock and WIP 402 634
Debtors 656 768
Bank 122 42
Preliminary expenses not
written off 18 -
3,364 4,054

The following additional information is relevant:-

(i)During 1985 a bonus issue, out of reserves, was made of one fully paid share for every four held
at the beginning of the year. The issue was made to ordinary shareholders only. Preference
shareholders were paid full dividend for 1985 in July 1985.

(ii)Quoted investments were sold at profit of shs. 62,000.

24 Introductory Financial Accounting

(iii)A machinery item with a book value of shs. 90,000 was sold for shs. 76,000 and new
machines bought for shs. 400,000. New motor cycle was bought at shs. 50,000 and included as
motor vehicles, while furniture costing shs. 30,000 were added.

(iv)No buildings were bought in 1985.

(v)Debentures were redeemed (paid off) at 110 (i.e. at 10% more), premium on redemption being
immediately written off to Profit and Loss account.

Required:

(i)Prepare a funds flow statement showing how the change in working capital has come about.

(ii)A detailed statement indicating the movement in the working capital items.

(Prof. I, November 1991)