Fund flow statement analysis is one of the simplest and the basic tools for stock analysis. Fund flow statement analysis helps investors in identifying the key areas of utilization of funds for a company during any period along with the key sources of those funds. Fund flow analysis provides great help to investors in finding companies, which are giving loans to promoters/related parties, doing significant capital expenditure, investments in subsidiaries etc.
More importantly, fund flow statement analysis helps the investors in identifying from where the company got this money, which it is now giving as loans to promoters/related parties/subsidiaries etc. An investor can easily find out whether the company is giving away the money, which it earned in profits or it is taking costly loans from banks and then forwarding this money to promoters/related parties. If the company is taking loans from banks to give it to promoters, then an investor would note that the company is doing so at the cost of public shareholders. This is because, the benefits of the money are being enjoyed by the promoters, whereas it will be the company (including public shareholders) who will have to repay the loan & interest to the banks.
Therefore, we believe that the simple exercise of fund flow statement analysis can help an investor check the shareholder friendliness, integrity and honesty of the promoters/management within a short period of time. As is usually said, “To know the truth, follow the money“. Therefore, fund flow analysis is the tool, which lets investors follow the money and bring to the light a lot of hidden aspects of the promoter/management decisions. This in turn lets the investor know whether her interests are being cared for by the company/management.
The current article provides an introduction to fund flow statement analysis with real-life examples of companies as a live demonstration of the concept. The article also provides answers to some of the important queries related to the fund flow analysis asked by investors.
What is Funds Flow Statement Analysis?
Movement of funds in the company’s balance sheet can be assessed by doing a comparative assessment of different sections of the balance sheet. An investor should compare the values of every section at the reporting date of the current year and the previous year and calculate the change in their values.
1) Equities and Liabilities:
In the liabilities section, any increase in an item means that the company has received funds (inflow), which need to be paid to external parties like:
- shareholders (equity and reserves),
- lenders (long term debt, short term debt etc),
- vendors (trade payables),
- customers (advances from customers usually part of other current liabilities)
- employees (leaves, gratuity etc. as part of short term provisions)
Similarly, a decrease in any item in the liability section means that the funds have gone out (outflow) from the company to third parties to satisfy the existing liability.
In the assets section, any increase in items means that the company has spent funds (outflow) to purchase assets, which would generate cash/funds inflow in future like:
- Fixed assets (purchase of plant and machinery)
- Long term loans & advances/Non-current investments (investments in long term financial products, JVs, subsidiaries etc.)
- Current Investments (investments in short term financial products)
- Inventory (raw material)
- Trade receivables (payment due from customers)
- Cash & equivalents (bank balance)
- Short term loans & advances (loans to related parties, vendors etc.)
Similarly, a decrease in any item in the assets section means that the funds have come into the company (inflow) from third parties by way of sale of assets or collection of dues from third parties.
This contrasting interpretation of directional change (increase/decrease) in items in liabilities and assets sections and their impact on funds statement (inflow/outflow) becomes confusing for many investors. Therefore, it is essential that the reader spend extra care while interpreting the funds flow analysis.
To understand further, let’s see examples of a few companies where fund-flow analysis is used to make insightful interpretations.
Live Illustration of Fund Flow Statement Analysis
Supreme Industries Ltd:
In the screenshot below, the balance sheet items, which have increased in FY2020 when compared to FY2019 contain a “+” sign in front of them and the items, which have decreased in FY2020 from FY2019 carry a “-” sign in front of them. In addition, all the items that indicate a funds inflow have been shown in “Green” and all the items leading to funds outflow are shown as “Red”.
Therefore, a decrease in assets like “Investment in associate” or “Trade receivables” have “-” signs as their values have decreased in FY2020 when compared to FY2019; however, these are shown in “Green” colour as a decrease in the asset is a fund inflow.
Similarly, a decrease in liabilities like “Trade Payables-Others” or “Other current liabilities” have “-” sign as their values have decreased in FY2020 when compared to FY2019 and it is shown in “Red” colour as a decrease in liability is a fund outflow.
FY2020 annual report, page 112:
Please note Supreme Industries Ltd has a large balance sheet size of thousands of crores Rupees. Therefore, to simplify the analysis, we have skipped items that have changed by less than ₹5 cr over FY2019-2020. This is because an analysis of the items showing large changes is sufficient to give us the main picture of the fund flow analysis with respect to major sources of funds and major utilization of funds. Leaving out the items showing minor changes simplifies the analysis whereas only creating small rounding-off impacts.
The fund-flow analysis depicts that in FY2020, Supreme Industries Ltd has received funds from the following sources:
- Increase in Borrowings: ₹250 cr
- Other equity (primarily retained earnings): ₹107 cr
- A decrease in Trade receivables: ₹75 cr
- Increase in Finance lease liabilities: ₹30 cr
- Increase in Other financial liabilities: ₹23 cr
- A decrease in Investment in associate: ₹15 cr
- Increase in Deferred tax liabilities: ₹12 cr
- Total: ₹512 cr
Therefore, an investor notices that out of ₹512 cr, a major portion of funds (₹432 cr) has come from the retained earnings (₹107 cr), borrowings (₹250 cr), and from the collection of receivables due from customers (₹75 cr). (432 = 107+250+75).
So, Supreme Industries Ltd relied primarily on its profits, debt and collections to raise funds for FY2020.
The analysis also indicates that these funds have been used by the company in FY2020 in the following manner:
- Increase in Cash & cash equivalents: ₹187 cr
- Increase in Inventories: ₹140 cr
- Increase in Right to use – lease: ₹59 cr
- Increase in Other non-current assets: ₹43 cr
- Purchase of Property, plant & equipment: ₹32 cr
- A decrease in Other current liabilities: ₹27 cr
- A decrease in Trade payables-Others: ₹11 cr
- Increase in Other bank balance: ₹6 cr
- Increase in Other financial assets: ₹5 cr
- Increase in Other current assets: ₹5 cr
- Total: ₹515 cr
An investor notices that the major usages of funds (₹472 cr) by Supreme Industries Ltd has been in inventories (₹140 cr), plant & machinery (₹32 cr), cash & investments in bank etc (187+6+5=₹198 cr), other non-current assets (₹43 cr) and right to use – lease assets (₹59 cr). (472=140+32+198+43+59).
To understand the details of different usages like “other non-current assets” and “right to use – lease assets” and the purpose of investments in these items, an investor needs to see their breakup under detailed notes to the financial statements.
When an investor analyses Supreme Industries Ltd, then she notices that the increase in “other non-current assets” is primarily due to an increase in balances with govt. authorities (primarily tax payments = ₹33 cr) and increase in capital advances (for expansion projects = ₹12 cr).
FY2020 annual report, page 122:
On further analysis, the investor notices that the “right to use – lease” asset is created due to the adoption of a new accounting standard, IndAS 116 that reclassifies how a company treats its leased assets like building/office spaces etc. So, this basically is an investment in leased assets.
FY2020 annual report, page 102:
On transition to Ind AS 116 “Leases”, for these leases, lease liabilities were measured at the present value of remaining lease payments, discounted at the Company’s incremental borrowing rate as at April 01, 2019. Right to Use if measured either at an amount equal to the lease liability adjusted by the amount of any prepaid or accrued lease payments.
After an overview of the usage of funds indicates that most of the money raised by Supreme Industries Ltd in FY2020, is kept by it in banks as cash & investments (₹198 cr), another major portion of the funds was consumed in inventories (₹140 cr), around ₹45 cr was consumed in payments to govt. authorities and capital advances, ₹32 cr in investment in plant & machinery and ₹59 cr in leased assets.
When the investor looks at the above usage of funds along with the major sources of funds (₹250 cr from borrowings, ₹107 cr from profits/retained earnings and ₹75 cr from the collection of trade receivables), then the investor feels that the company has effectively borrowed ₹250 cr from lenders and put it as cash & investments with banks (₹198 cr).
In light of the above analysis, an investor may conclude that raising money just to keep it in the bank might not be the best usage of the money. Nevertheless, it might be that the company plans to use this money early in the next financial year i.e. FY2021. Therefore, an investor may analyse the financial position of the company in the coming quarters to understand if it could use this money that it borrowed and then kept in the bank. If the company is able to use it in its business, then it is fine otherwise, it may not be the best strategy to borrow the money and let it lie in the bank.
While conducting the fund flow analysis, an investor should focus on the broad picture. She should focus on what are the large fund inflows and what are the large fund outflows.
She may find instances where most of the funds have come from profits/retained earnings and have been used largely for investments in plant & machinery, which is a healthy pattern. In addition, she may also find instances where most of the funds came from profits and the company could not use them for plant & machinery as there is no capital expansion project underway. Therefore, the company may use them to repay the debt (i.e. reduction in borrowings on the balance sheet) or may put that in the bank (increase in cash & equivalents or financial investments).
These are healthy patterns as the funds are generated from genuine business activities and are used in genuine business usages like capital expenditure, debt repayments or keeping it as an investment for future use.
On the contrary, an investor may come across fund flow statements where the company is making losses (i.e. reduction in reserves or other equity) and the company is raising funds from borrowings and using it to make investments. The investor should be very cautious if, on detailed analysis, she finds that the investments may be for taking money out of the company in the form of non-current investments in promoter-owned entities or loans & advances to related parties (promoter-owned entities).
Therefore, an investor should do a fund flow statement analysis of each company before making a final decision. It is a short exercise where attention to the large inflows and outflows have the potential to unearth management intentions, integrity and strategic business decisions.
Let us see an example where the fund flow analysis highlighted taking out of the funds from the company.
Using Fund Flow Analysis to identify syphoning of Funds by Promoters
Fund flow analysis has the potential of highlighting and early-stage identification of cases where management uses funds generated from the company (profits/reserves and debt) for its own benefits in form of loans and advances to group companies/promoter entities.
The case of Gujarat Automotive Gears Limited (GAGL) is a pertinent example of funds diversion by the promoter/management, in which the majority shareholder/promoter/management took out the profits of GAGL and made it take debt, which GAGL did not need for its operations and used these funds to give loans to themselves. Promoters of GAGL (HIM Teknoforge Limited) in turn benefited at the cost of GAGL shareholders.
We highly recommend that an investor should read the detailed analysis of GAGL in which the funds’ diversion was identified by way of funds flow analysis in the following article:
We are providing a section of the fund flow analysis of GAGL below to help investors understand the immense help provided by fund flow analysis in the management analysis of any company:
Gujarat Automotive Gears Ltd:
Gujarat Automotive Gears Limited is a small-cap company with a market capitalization of ₹33 cr. it was established in Baroda in 1973. The company makes auto and tractor components including transmission gears and axle shafts. Its products target OEMs and after-markets in India and sell under the brand name of KAG in India. The company also exports its products and has United States of America, Germany, Italy, United Kingdom, Belgium, Egypt, Dubai, Sri Lanka, Singapore, Malaysia, Thailand, Australia etc. as its overseas markets.
Analysis of Gujarat Automotive Gears Limited revealed that it was a great business. The following financial performance would reflect that the company has been showing the picture-perfect image of a good business:
- Sales had been increasing at a good pace (17%)
- Profits had been increasing at an even higher pace
- All the profitability margins were at respectable levels and were improving further
- The company was a debt-free company and
- Has a cash chest, which was increasing year on year because its business was a cash cow.
Such a business is always a prize catch to investors and there was no surprise that in July 2013, the company was acquired by HIM Teknoforge Limited for ₹21.8 cr. when it purchased the 55% shareholding of erstwhile promoters.
The company went on with its business as usual under the new promoters and finished the next year, FY2014, by generating the highest ever sales of ₹29 cr. and profits of ₹5 cr.
However, the investors were in for a surprise when the balance-sheet of Gujarat Automotive Gears Limited at March 31, 2014, was made public and it showed that the cash holding has reduced from ₹6cr. in FY2013 to ₹1 cr. in FY2014.
The usage of cash remained a key issue to be found out as the company has not used it to pay a dividend to its shareholders.
The analysis of the balance sheet at March 31, 2014, showed that Gujarat Automotive Gears Limited has utilized its existing cash reserves (decline by about ₹5 cr.) as well as the profits generated in the year FY2014 (increase in reserves & surplus of about ₹4.5 cr) to provide loans & advance to some entity (increase by about ₹10 cr.).
The balance sheet of Gujarat Automotive Gears Limited showed that it had only about ₹3 cr invested in the fixed assets used to make products to generate its sales & profits, whereas it has given a loan of about ₹10 cr to some entity. Such kind of loan, which makes loan assets more than fixed assets reflected that the management of Gujarat Automotive Gears Limited is finding more value in lending the money than investing it in its core business.
As this business decision of the Gujarat Automotive Gears Limited had important implications, it becomes imperative for any investor to find out who is the entity to whom this loan has been given.
The investors could find these details in the annual report of Gujarat Automotive Gears Limited for FY2014, in a section called “Related Party Transactions”:
Details in the related party transactions section revealed that Gujarat Automotive Gears Limited has given a loan (inter-corporate deposit) of ₹9 cr. to HIM Teknoforge Limited in FY2014.
This action by Gujarat Automotive Gears Ltd meant that it has used its cash reserves and its entire profits for FY2014 and used it to give a loan to HIM Teknoforge Limited. HIM Teknoforge Limited is no one but the new promoter of Gujarat Automotive Gears Limited, who has acquired it in July 2013 by buying 55% of the shares in the company.
It effectively meant that the new promoter, HIM Teknoforge Limited, within a few months of acquisition of Gujarat Automotive Gears Limited has used it as a source of funds (to the extent of ₹9 cr) to serve the purposes of HIM Teknoforge Limited. I doubt that minority shareholders could have controlled the loan, which HIM Teknoforge Limited being the management & largest shareholder, made Gujarat Automotive Gears Limited to give to itself.
When an investor continues further with the fund flow statement analysis of Gujarat Automotive Gears Ltd for next few years as highlighted in the article: Why Management Assessment is the Most Critical Factor in Stock Investing?, then she notices that within next 3 years, the new promoter, HIM Teknoforge Ltd, took out more than ₹25 cr. from GAGL, which is even more than ₹21.8 cr, which it had paid to acquire control of GAGL.
The fund flow statement analysis in the above case shows that GAGL has effectively funded its own acquisition. This is because, over the next 3 years, the company has given more money than the acquisition cost to the new promoter.
Therefore, we believe that along with a very good financial analysis tool, the fund flow statement analysis is a very important tool for management analysis. This is because it helps investors understand what is the company doing with the money; from where it is raising the money and where it is using the money. Fund flow analysis opens up answers to a lot of such questions, which are otherwise never resolved for investors.
In addition, investors would note that fund flow statement analysis also provide inputs about:
- whether the debt position of the company is improving or deteriorating by observing increasing or decreasing debt levels
- whether the receivables position of the company is changing for better or worse by noticing an increase or decrease in trade receivables when compared with sales performance
- Status of project progress:
- In case capital work in progress (CWIP) is increasing, it would mean that the work on the project under implementation is progressing
- In case CWIP has decreased and net fixed assets (NFA) has increased, it would mean that most probably the under-construction project has been completed and has been transferred from CWIP to NFA
Thus an investor can get multiple useful information points even from the cursory overview of summary balance sheet disclosed with financial results.
In light of the above, we believe that it is essential for every investor to conduct fund flow analysis on the companies she analyses for investing. It is a simple but very effective tool to understand the management intentions, integrity and shareholder friendliness.
Let us now get further clarifications to the concept of fund flow analysis by answering important queries asked by investors:
Readers’ Queries about Fund Flow Statement Analysis
Can inventory losses (write-down) lead to erroneously inflated funds inflow?
I understand that while calculating cash flow from operations (CFO), we adjust for the working capital (WC) changes to arrive at CFO.
While analysing the CFO calculation of a commodity type business, I saw that the changes in the inventory led to the addition of a large amount of inflow in CFO and thus heavily inflated the CFO.
The company in question uses commodity as raw material (RM). The raw material/inventory was valued at very high prices last financial year inventory closing as the commodity was at its cyclical peak. However, in the recent year commodity prices has corrected to very lows (recent year inventory values). Therefore, the value of inventory at the end of the year has come down significantly. I understand that while adjusting for the working capital in CFO calculation, the reduction in the value of inventory on the balance sheet during a year is shown as cash inflow.
Therefore, I feel that the losses in the inventory held by the company due to a decline in the price of the commodity have the potential of inflating the CFO.
So while analysing the fund flow analysis from the balance sheet or cash flow analysis, how should we consider such changes, which may not be real?
Thanks for writing to us!
We believe that in such cases of inventory write-down only a case to case based awareness is sufficient for investors and no change to the general method of CFO calculation is needed.
Let us see the impacts on both the balance sheet fund flow analysis as well as the cash flow from operations (CFO) calculation in the case of inventory write-down.
1) Fund flow statement analysis from the balance sheet:
The decline in inventory will be factored in profit & loss statement as a loss/expense, which will reduce the profits and in turn will reduce the retained earnings (shareholders equity).
If we ignore all other transactions, then in the fund flow analysis, the fund inflow due to decline in an asset (inventory) will be matched with fund outflow due to decline in shareholders’ equity (reduction in retained earnings due to loss in P&L because of inventory write down).
2) Calculation of cash flow from operations (CFO):
The positive entry of change in inventory in the CFO calculation under working capital changes nullifies the impact of loss recognised in the P&L due to inventory write down. This positive entry in CFO does not inflate CFO but cancels out the impact of reduction from loss due to inventory write-down in the profits.
If we do not add the positive change due to reduction of inventory in CFO, then the CFO will be unduly reduced from inventory write-down losses (which is a non-cash item).
Hope it answers your queries.
All the best for your investing journey!
Dr. Vijay Malik
How to determine equity contribution in Fund Flow Statement Analysis?
Hi Dr. Malik,
I learned fund flow analysis from your class in Bangalore and I am trying to implement it for KRBL Ltd. However, I am unable to figure out which number needs to be used when calculating “Equity”. Should we be using:
- The difference between last year’s equity and current year’s equity or
- PAT for the current year to come to a conclusion?
Any help would be much appreciated 🙂
Thanks for writing to us!
In the case of fund flow analysis, while comparing the balance sheet of two years, we use the difference in the Equity (equity is the sum of equity capital and reserves & surplus).
Further advised reading: Understanding the Annual Report of a Company
The change in equity would be a result of retained earnings (PAT – dividend including dividend distribution tax) and other sources like equity raising due to IPO/FPO etc. or equity reduction due to buybacks etc.
We cannot use PAT straightaway in fund flow analysis because as mentioned above, a few other things other than PAT would also impact equity: like dividend distribution, equity raising or equity reduction etc.
All the best for your investing journey!
Dr. Vijay Malik
Will the fund inflow and fund outflow be always equal in Fund Flow Statement?
Dear Dr. Malik,
Many thanks for this article. Though I read the funds flow statement in MBA, never really applied it while analysing a company. Of course, I used to look at the movement of assets and liabilities, and check the cash flow statement, however, putting it down and seeing the movement does help. I have already incorporated this to a few companies that I am tracking now.
Just one question. When we check the overall figure, should the funds received be greater than or at least equal to funds used, for us to safely infer that the company is using the primary source of funds to repay the debt? Have you come across any instance where the total funds used is greater than the total funds received? Sorry if this is a stupid question. Thanks a lot.
Thanks for writing to me! I am happy that you found the article useful.
I am happy that you have started using the funds’ flow in your stock analysis. It is a very good tool to weed out shareholder unfriendly managements.
The funds’ movement also follows the double-entry system and therefore, the sources of funds (received) will always be equal to the usage of funds (usage). In the above example, I have done some rounding off, therefore, there might be some mismatches in receipts and usage. Otherwise, if you conduct this exercise by transferring the summary balance sheet in excel, then usage would match the receipts.
Hope it clarifies your queries! All the best for your investing journey!
Why the increase in cash & equivalents is a fund outflow?
Sir, if there is an increase in cash and cash equivalent of the current asset section, is it not an inflow of money rather than outflow? How it can be an outflow of a fund?
Thanks for writing to me!
Increase in cash & equivalents is an increase in an asset (bank balance), which can be understood as a cash outflow from the company to the Banks which leads to an increase in the asset of bank balance. It is similar to the cash outflow from the company when it buys any investment product. Investment in such products leads to cash outflow from the company and resultant increase in holding of the financial/investment product like mutual funds etc.
Hope it clarifies your queries!
All the best for your investing journey!
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