Funds from operation under a working capital

Funds from operation under a working capital concept are based on accrual accounting procedure in that sales, whether credit or cash, are recognize as a source of working capital. Likewise, purchases whether credit or cash are considered as a use of working capital. But, under the cash concept of funds, we are concerned with the cash basis of accounting.  Only cash sales and cash receipts from debtors against credit sales are recognized as a source of cash. Similarly, cash purchases and cash payment to the suppliers for credit purchases are regarded as the use of cash. The same holds true for other expenses and income. No consideration is to be given for outstanding and pre-paid expenses and income.

Thus, every item in the profit and loss account is altered in converting it to the cash approach. Some of the items of adjustment of the profit and loss account in the cash flow approach would be the same as in the funds statements, for instance, depreciation on plant and equipment, amortization of various deferred revenue expenses and so on. Since items do not involve any corresponding out flow of funds, they are added back to determine funds from operations in funds statements. The logic that is applied in the funds statement also applies in the cash flow statement, but the current assets and is required to be extended further Cash is only one of the current assets and is part of the net working capital. Therefore, the changes in all of the other current assets and in the current liabilities must be analysed in relation to their effect on cash.