What are the Sources and Uses of Funds Statements?

Sources of Funds

There are some notable sources of funds or working capital for firms in their financial statements. These sources are as mentioned below −

Funds from Operations

The most important source of funds for a firm is its profit from operations. As all companies work to gain as much profit as possible, it is easy to realize why funds gained from operations are so popular in nature. The major source of information of profits for a firm is the profit and loss account. However, the profit and loss account may contain some sources that do not affect the working capital. So, in order to get the real working capital amount, the net profit of the firm needs to be adjusted.

One of the items that do not affect working capital (funds) is depreciation. Depreciation reduces owners’ equity like all other expenses. However, depreciation does not reduce current assets (cash) or increase current liabilities. Depreciation reduces non-current assets without having any effect on cash.

Therefore, whereas calculating working capital, depreciation must be added to net profit. So, if depreciation is not added to net profit, the real funds statement will lack the quantity of real funds. The same policy is applicable to amortized expenses, such as goodwill.

It must be realized that depreciation is not a source of funds like revenues. Unlike other operating expenses, depreciation does not use working capital. So, it should not be considered a source of the working capital item. However, this is not true because depreciation is tax-deductible. The amount lost due to depreciation can be utilized to pay back the taxes. So, it is part of the working capital for the firms that have assets.

Gain or Loss from Non-Current Assets

Net profit is also affected by the sale of non-current assets. In case of gain, the gained amount should be subtracted whereas in the case of loss, the amount should be added to net profit. The sale of non-current assets is listed separately in calculating the source of working capital. So, the net profit from operations must be adjusted when a gain or loss to non-current assets occurs.

Firms also reiterate raising funds externally by issuing shares or borrowing from the markets on a long-term basis.

Uses of Funds

Prominent uses of funds include the following −

  • Adjusting net loss from operations

  • Buying non-current assets

  • Repayment of short term debt (bank loans) or long-term debt (debentures or bonds)

  • Redemption of redeemable preference shares

  • Payment of cash dividends

Other uses of funds are as follows −

  • Net loss eats the profit and working capital of a firm. It occurs when the net profit of a company is below the net expenses made in operations.

    In other words, net loss occurs when there is a gap between the expenses and revenues. If the expenses are greater than revenues, loss occurs.

  • The items that involve no working capital, such as depreciation, need to be adjusted to net loss. Non-funded expense items are added to net loss whereas gains or losses due to the sale of non-current assets must also be adjusted.

  • Companies may also use funds to acquire non-current assets, such as land and building, office equipment or machinery. It may also use working capital to pay bank loans and bonds/debentures.

  • An additional use of funds is in the case of redemption of redeemable preference shares. Moreover, a profitable venture also uses its funds for paying dividends to its equity preference shareholders. The idea is to satiate the need of all lenders and creditors so that the money borrowed from investors and the capital markets can be paid at the earliest.