IGNOU : M.COM : MCO 5 : UNIT 6 : Q - 2. Discuss a few basic differences between “cash” concept of funds flow statement and “working capital” concept of funds flow statement.

Ans. STATEMENT OF CHANGES IN FINANCIAL POSITIONS--- CASH BASIS

There are two versions of the statement of changes in financial position. The first version is called cash basis and the second one is called working-capital basis. The cash basis of changes in financial position is to an extent close to cash flow statement though it is presented in a different manner. This statement first takes revenue and then removes all non-cash revenues and all cash related revenues which are not recognised in computing revenues. In other words, at this stage, we are interested to find out how much of cash is generated under revenue head without bothering whether such revenue pertains to current year, previous year or next year. Similarly, we consider expenses and then remove all non-cash expenses and consider all cash expenses of previous period as well as next period but not considered under the expenses value. For example, if there is a payment for outstanding liability of previous year, it is also considered. The difference of these two is funds or cash from operating activities. Next, cash received from other sources are considered. In the last step, uses of cash for capital transactions are considered to find out the net difference between the sources and uses. The net difference shall be equal to net changes in cash.

The main limitation or shortcoming of this method is its failure to segregate current year income/expenses with other period income/expenses. Our next statement overcomes this issue.

STATEMENT OF CHANGES IN FINANCIAL POSITIONS--- WORKING CAPITAL BASIS

As stated earlier, our main funds flow statement excludes all past and future items and follows accrual and matching principle. Any such outstanding expenses or prepaid expenses or income received in advance, etc. are adjusted in a separate statement called working capital statement. Funds flow statement under this method is prepared in two stages. The following diagram illustrates the concept.

assets	Liabilities + equity
fixed assets	permanent capital share capital + reserve long – term loan
Current assets	Current Liabilities

 

Funds derived from permanent capital are reduced by funds used for fixed assets acquisition. The balance is the amount available for working capital purpose. The working capital statement shows the difference between the current assets and current liabilities. Thus the above format clearly brings out how much of long-term funds are used for working capital or how much of short-term working capital is used for long-term purpose.