Cash Flow vs Fund Flow: Key Differences Every Finance Student Should Know

When analysing a company’s finances, one key question often comes up: where is the money going? That’s where cash flow and fund flow statements come into play. While both track how money moves, they focus on different areas—cash flow deals with immediate liquidity, whereas fund flow captures long-term changes in working capital.

This blog delves deeper into the cash flow vs fund flow debate. It explains the key differences between the two and how each is used to assess a company’s financial health.

What Is Cash Flow?

Cash flow refers to the movement of money in and out of your business or personal finances. It shows how much cash is available at any given time. Positive cash flow means more money is coming in than going out, while negative cash flow indicates the opposite. It is vital for daily operations and long-term financial health.

Types Of Activities In A Cash Flow Statement

The three different types of activities in cash flow statements are:

1. Operating activities

Operating activities reflect the cash generated or spent from a company’s core business functions. This section adjusts net income for non-cash items like depreciation and changes in working capital. It captures cash inflows from customer receipts and outflows for vendor payments, salaries, rent, and taxes. Importantly, this part helps investors evaluate whether the business can generate enough cash to sustain operations without relying on external funding. Consistent positive cash flow from operating activities often signals a healthy and self-sustaining business model.

2. Investing activities

Investing activities include cash movements from purchasing or selling long-term assets and investments. This section shows how much a company spends on physical assets like property, plant, and equipment or earns from selling them. It also includes cash used in or received from mergers, acquisitions, or the sale of subsidiaries. A high cash outflow in this section indicates that a business is expanding, while inflows may suggest asset liquidation. This information is useful in understanding the company’s growth strategy and asset management efficiency.

3. Financing activities

Financing activities report cash flows related to the company’s capital structure changes. This involves issuing shares, borrowing or repaying loans, and paying dividends. For example, proceeds from issuing equity or debt appear as inflows, while repayments, buybacks, and dividend payouts are outflows. This section reveals how a company funds its operations and growth through debt, equity, or internal reserves. A pattern of heavy borrowing or frequent equity issuance may raise questions about long-term financial stability or ownership dilution.

Advantages And Disadvantages Of Cash Flow Statements

Cash flow statements are essential tools for financial reporting and analysis, and are mandatory for financial reporting. Actual cash movements can help traders to analyse and gain insights into a company's immediate financial standing.

Advantages of Cash Flow Statements

• Liquidity Assessment: These statements can provide a clear picture of the company's cash generation ability. It can also define its ability to meet its immediate short-term obligations and debts.
  
• Operational Efficiency: They can help evaluate how effectively a company's core operations are generating cash. This is the main measure of self-sustainability.
  
• Reliability: It is essential to know whether the company only handles cash transactions. Are the figures less subject to management judgment than accrual-based net income?
  

Disadvantages of Cash Flow Statements

• Limited Scope: Cash flow statements focus only on cash and cash equivalents, excluding non-cash items like depreciation and credit sales. This can affect profitability analysis.
  
• Incomplete Picture of Solvency: The statements alone cannot fully assess long-term solvency. Liquidity also depends on assets that can be quickly converted to cash.
  
• Timing Differences: The timing of cash receipts and payments can influence the cash position. It may not always reflect the fundamental economic reality.
  

A Step-By-Step Guide To Preparing A Cash Flow

Here is how you can prepare a cash flow:

• Step 1: Begin by noting the opening cash and cash equivalents from the start of the period.
  
• Step 2: Use the indirect method by starting with net profit. Adjust it for non-cash items like depreciation and changes in working capital (like receivables and payables).
  
• Step 3: Next, record cash used in or earned from investing, such as buying or selling fixed assets, property, or investments.
  
• Step 4: Then include inflows from loans, issuing shares, or outflows like loan repayments, dividend payments, or share buybacks.
  
• Step 5: Add all three sections, operating, investing, and financing, to calculate the net increase or decrease in cash.
  
• Step 6: Add the net cash flow to the opening balance. This gives you the closing cash balance for the period.
  

What Is Fund Flow?

Fund flow refers to the movement of funds in and out of a business over a specific period. It shows how a company raises and uses its financial resources, focusing on long-term sources and applications of funds. Unlike a cash flow statement, fund flow highlights changes in working capital and helps understand a firm’s financial stability, investment decisions, and overall financial planning.

A Step-By-Step Guide To Preparing A Fund Flow

Here is how you can prepare a fund flow:

• Step 1: Begin by collecting the balance sheets of the current and previous years.
  
• Step 2: Prepare a statement showing the increase or decrease in current assets and current liabilities to find the change in working capital.
  
• Step 3: Look for increased non-current liabilities and equity items. These include loans raised, shares issued, or fixed asset sales.
  
• Step 4: Note the uses of funds, such as purchasing fixed assets, repaying loans, or paying dividends.
  
• Step 5: Use the formula: Fund from Operations = Net Profit + Non-cash expenses – Non-operating incomes.
  
• Step 6: Finally, create the fund flow statement by listing all sources and applications of funds, ensuring the total matches.
  

Advantages and Disadvantages of Fund Flow Statements

Fund flow statements can provide a strategic and long-term perspective on how a company manages its financial resources and capital structure.

They are tools that can help in capital budgeting and resource allocation.

Advantages of Fund Flow Statements

• Capital Allocation Insight: Cash flow statements can help the management understand how financial resources are sourced (such as loans, equity) and applied (like purchasing long-term assets, debt repayment).
  
• Long-Term Strategy: It can provide a broader view of changes in the financial position over time, making it useful for long-term planning and investment decisions.
  
• Working Capital Focus: It can highlight the changes in working capital. This is the main indicator of the company's ability to manage its current assets and liabilities effectively.
  

Disadvantages of Fund Flow Statements

• Complexity: They can be more time-consuming to prepare and interpret than cash flow statements. It requires comparative balance sheet data.
  
• No Cash Position: The statement does not directly reveal the company's real-time cash balance or short-term liquidity. The simultaneous use is required.
  
• Historical Data: As two balance sheets are compared, the data is historical and may not be helpful in making quick, real-time management decisions.
  

Conclusion

Understanding the difference between cash flow and fund flow is essential for every finance student. Cash flow focuses on the actual movement of cash in daily operations, while fund flow tracks the changes in working capital and long-term finances. Both provide valuable insights into cash flow for short-term liquidity and fund flow for overall financial health. Together, they help businesses manage money effectively and make informed financial decisions.

Sources

Investopedia
Economic Times