The term ‘flow’ means movement and includes both ‘inflow’ and ‘outflow’. The term ‘flow of funds’ means transfer of economic values from one asset of equity to another. Flow of funds is said to have taken place when any transaction makes changes in the amount of funds available before happening of the transaction. If the effect of transaction results in the increase of funds, it is called a source of funds and if it results in the decrease of funds, it is known as an application of funds. Further, in case the transaction does not change funds, it is said to have not resulted in the flow of funds. According to the working capital concept of funds the term ‘flow of funds’ refers to the movement of funds in the working capital. If any transaction results in the increase in working capital, it is said to be a source or inflow of funds and if it results in the decrease of working capital, it is said to be an application or out flow of funds.
The flow of funds occur when a transaction changes on the one hand a non current account and on the other a current account and vice- versa.
When a changes in a non current account e.g., fixed assets, long-term liabilities, reserves and surplus, fictitious assets etc., is follow by a change in another non-current account, it does not amount to flow of funds. This is because of the fact that in such cases neither the working capital increases nor decreases. Similarly, when a change in one current account results in a change in another current it does not affect funds. Funds move from non current to current transactions or vice- versa only. In simple language funds move when a transaction affects
A current asset and fixed asset
A fixed and current liability
A current asset and a fixed liability
A fixed liability and a current liability
And funds do not move when the transaction affects fixed assets and fixed liability or current assets and current liability. To understand flow of funds, it is important to classify various accounts and balance sheet items into current and non- current categories. Current account can either be current assets or current liabilities. Current assets are those assets which in the ordinary course of business can be converted into cash with in a short period of normally one accounting period. Current liabilities are those liabilities which are intended to be paid in the ordinary course of business with in a short period of normally one accounting year out of the current assets or the income of the business.
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