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Funds Analysis

The second portion of our examination of the tools of financial analysis and planning deals with the analysis of funds flows and cash flows and with financial forecasting. A flow of funds statement (also known as a sources and uses of funds statement or a statement of changes in financial position) is a valuable aid to a financial manager or a creditor in evaluating the uses of funds by a firm and in determining how the firm finances those uses. In addition to studying past flows, the financial manager can evaluate future flows by means of a funds statement based on forecasts. Until 1989, all US corporate annual reports were required to present flow of funds statement in addition to a balance sheet and income statement. The cash flow statement now officially replaces the flow of funds statement in annual reports. The purpose of the cash flow statement is to report a firm's cash inflows and outflows - not its flow of funds - segregated into three categories: operating, investing, and financing activities. Although this statement certainly serves as an aid for analyzing cash receipts and disbursements, important current period investing and financing noncash transactions are omitted. Therefore the analyst will still want to prepare a flow of funds statement in order to more fully understand the firm's funds flows.

Another major tool, the cash budget, is indispensable to the financial manager in determining the short-term cash needs of the firm and, accordingly, in planning its short-tern financing. When cash budgeting is extended to include a range of possible outcomes, the financial manager can evaluate the business risk and liquidity of the firm and plan for a real istic margin of safety. The financial manager can adjust the firm's liquidity cushion, rearrang the maturity structure of its debt, arrange a line of credit with a bank, or do some combination of the three.

The preparation of forecast balance sheets and income statements enables the financii manager to analyze the effects of various policy decisions on the future financial condition and performance of the firm. Such statements may derive from the cash budget or be based on past or projected financial ratios and/or other assumptions. We examine each of these tools in turn.

The final method of analysis, contained in an Appendix to this chapter, involves sustainable growth modeling. Here we determine whether the sales growth objectives of the compan are consistent with its operating efficiency and with its financial ratios. This powerful tool of analysis allows us to simulate the likely effects of changes in target ratios when we move from a steady-state environment.

Cash budgeting, the preparation of forecast statements, and even sustainable growth modeling are made easier through use of a computer spreadsheet program. Such programs arc readily available for financial analysis and planning.

Alternative "Funds" Definitions

The financial manager makes decisions to ensure that the firm has sufficient funds to meet financial obligations when they are due and to take advantage of investment opportunities. To help the analyst appraise these decisions (made over a period of time), we need to study the firm's flow of funds. By arranging a company's flow of funds in a systematic fashion, the analyst can better determine whether the decisions made for the firm resulted in a reasonable flow of funds or in questionable flows, which warrant further inspection.

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What Are Sources? Uses?

We prepare a basic, bare-bones funds statement by ( 1 ) determining the amount and direction of net balance sheet changes that occur between two balance sheet dates, (2) classifying net balance sheet changes as either sources or uses of funds, and (3) consolidating this information in a sources and uses of funds statement format. In the first of these steps, we simply place one balance sheet beside the other, compute the changes in the various accounts, and note the direction of change - an increase (+) or decrease (-) in amount. In step 2, each balance sheet item change is classified as either a source or use of funds, as follows:

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