RELEVANT COSTING FOR DECISION MAKING

Cost Accounting �

In earlier concept, costing was defined as the technique and process of ascertaining costs of a given thing. In sixties, the definition of cost accounting was modified as the � application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and ascertainment of profitability of goods or services.� It includes the presentation of information derived there from for the purposes of managerial decision making. It clearly emphasizes the importance of cost accountancy achieved during the period by using cost concepts in ore and more areas and helping management to arrive at good business decisions. To day the scope of cost accounting has enlarged to such an extent that it now refers to the collection and providing all sorts of information that assists the executives in fulfilling the organization goals. Modern cost accounting is being termed as management accounting, since managers being the primary user of accounting information are increasingly using the data provided by the accounts, setting objectives and controlling the operation of the business.
Cost accounting deals with the ascertainment of the cost of product or service. It is a tool of management that provides detailed records and reports on the costs and expenses associated with the operations, mainly for internal control and decision making. Cost accounting basically relates to utilization of resources, such as material , labour, machines,etc and provides information like product cost, process cost, service or utility cost, inventory value etc, so as to enable the management taking important decisions like fixing price, choosing products, preparing quotations, releasing or withholding inventory etc.

OBJECTIVE �

The objective of cost accounting is to provide information to internal managers for better planning and control of operations and taking timely decisions. In the early stages, cost accounting was considered as an extension of financial accounting. Cost records were maintained separately. Cost information and data aware collected from financial books,  since all monetary transactions are entered in the financial books only. After developing product cost or service cost and valuation of inventory , the costing profit and loss account is prepared. The profit and loss figures so derived by the two sets of books i.e. financial accounts and cost accounts would have to be reconciled, since some of the income and expenditure recorded in financial books do not enter into product cost, while some of the expenses are included in cost accounts on notional basis i.e. without having incurred actual expenses. However a system of integrated accounts has been developed subsequently wherein cost and financial accounts are integrated and one set of books can be maintained.  

Relevant cost-

The relevant cost is defined as that cost which has direct bearing upon the profitability of the company . For example the marginal cost is a relevant, which can be avoided if the production is not being undertaken. Where as the fixed cost is not a relevant cost because it has already been incurred and can not be avoided irrespective of whether production has been undertaken or not.

There are other examples of relevant costs as follows-

A)    Differential Cost- It is defined as a technique used in the preparation of ad-hoc information in which only costs and income differences between alternative courses of action are taken in to consideration. Cost may increase or decrease due to change in production, sale , production method, product mix, etc.This change in total cost at a particular level of activity compared to another one is called differential costs, which are obtained by subtracting costs at one level from those at a higher level. Differential cost calculation includes both variable as well   fixed costs which are affected by the alternative course of action. Thus, absorption costing or marginal costing techniques can present the information.

Example-
    Activity Level        75%        60%        Differential
Units            7500        6000        1500

Costs Elements        15000        12500        2500
Direct Materials        7500        6000        1500
Variable Overhead    3600        3000        600
Fixed Overheads    3900        3500        400
            Total    30000        25000        5000

Thus, the differential cost of 1500 units is Rs 1500. in the above presentation , if the additional output does not involve additional fixed costs, then variable costs becomes differential costs and in that case, the latter will have no difference with marginal cost.

Differential Cost             Vs             Marginal Cost

In fact, differential costs are often confused with marginal costs. This is because of the fact that both marginal costing and differential cost analysis system stm from the basic behavior of cost,i.e. fixed and variable . When fixed cost remain unaffected, both marginal costs and differential costs are the same . However they are not the same. The difference are as follows which will not be so under marginal costing.

a) Differential cost is a total concept and applies to a fixed additional quantity of output.
a)Marginal Cost is an unit concept and app lies to output per unit basis.
b) Differential Costs are presented in totals in both formats, i.e. under marginal as well as absorption cost techniques.
    b) Marginal Costing is presented by showing contribution per unit and fixed cost as total amount.
c)Product cost under differential cost analysis may contain fixed cost    c) Product cost under marginal costing contain only variable cost.

Uses of Differential Cost Analysis �

Differential cost analysis may be useful technique in taking appropriate policy decisions such as :-
1)    Acceptance of an additional order at lower than existing price to a special customer,
2)    Acceptance of a export order, requiring additional quality.
3)    Introduction of a new product.
4)    Opening of a new sale territory or Channel of distribution.
5)    Processing of a by- product or joint product beyond the split-off point.

 

Conclusion:

In all such cases, the differential cost is compared with incremental revenue. As long as incremental revenue is more than or equal to incremental or differential cost, the additional activity is justified. However, if differential cost exceeds incremental revenue the project should be abandoned.

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Use of Cost –Volume-Profit relationship

Cost-Volume-Profit Relationship-
Profit is always a matter of primary concern to management. The volume of sale never remains constant. It fluctuates up and down and income also goes up and down with fluctuations in volume. Profit is actually the result of interplay of different factor like cost, volume and selling price. Effectiveness of a manager depends on his capabilities to make right predictions about future profits. This can
be done when correct relationship existing between cost, volume and profit is known. For this reason, knowledge of relationship among cost, volume and profit is of immense help to the management. This knowledge of cost-volume-profit relationship helps management to find out right solution for such problems as are given below-
i) What should be the volume to be attempted for obtaining a desired profit?
ii) How will the change in selling price affect the profit position of the company?
iii) How will the change of cost affect profit /
iv) What should be the optimum mix of the company ?
Use of Cost –Volume-Profit relationship-
1) This relationship enables management to predict profit over a wide range of volume. This knowledge is very useful in preparing flexible budget.
2) In a lean business season, company has to determine the price of the products very carefully. It becomes necessary sometimes to bring down the price to boost the sale of a product, what impact this reduction in price is going to have no profit position of a company.
3) Analysis of cost-volume-profit relationship helps in decision-making. There are situation when management has to decide whether it should add to its capacity or not with the knowledge of cost-volume- profit analysis, a manager can easily take decision showing in its respect how utilization of available capacity will lead to increase profit.

Margin of Safety

Margin of Safety represents the difference between sales at a given activity nd sales at Break even point (BEP is the point of sale where company makes neither profit nor loss). Consequently it indicates the extent to which a fall in demand could be absorbed before the company begins to sustain losses. The margin of safety is expressed as percentage of sale. The validity of safety always depends on the accuracy of cost estimates. The wide margin of safety is advantageous for the company. Margin of safety depends upon the level of fixed cost, rate of contribution and level of sales.

Sales – Sales at BEP = Margin of safety.

Improvement in Margin of Safety-

The Margin of Safety can be improved by adopting the following steps-

i) Increase in sale volume- It widens the difference between sales at activity level and sales at break even point.

ii) Increase in selling price- If it is not possible to increase sales volume, selling price is increase to increase the margin of safety.

iii) Change in product mix thereby increasing contribution – This will lead to improvement in margin of safety , because it widens the gap of sales specified activity level and sales at break even point.

iv) Lowering fixed cost- It increases the margin of safety , because break even point goes down by lowering fixed cost.

v) Lowering fixed variable cost- It increases margin of safety by improvement in P/V ratio.

Angle of Incidence- The angle which the sales line makes the total cost lines, is known as angle of incidence. This angle gives pictorial relationship between products and sales. This angle indicates the profit earning capacity of a company over the break even point. A large angle of incidence will indicate earning of high margin of profit. Low angle of incidence indicates that variable cost forms a major part of cost of sales. Normally margin of safety and angle of incidence are considered together. For example, a high margin of safety with a large angle of incidence will indicate the most favorable condition of a company. Under such a situation, the company is monopolizing in the market. On the other hand, low margin of safety with low angle of incidence indicates bad financial shape of the company.

Main features of Marginal Costing-

i) Costs are divided in to two categories i.e. Fixed cost and variable cost

ii) Fixed costs are considered as period cost and remains out of consideration for determination of product cost and value of inventories.

iii) Prices are determined with reference to marginal cost and contribution margin.

iv) Profitability of departments and products is determined with reference to their contribution margin.

v) In presentation of cost data, display of contribution assumes dominant role.

vi) Closing stock is valued on marginal cost.

Basic Marginal Cost Equation

S-V= F+P

Where S= Sales

F= Fixed Cost

V= Variable cost

P= Profit.

Profit /Volume Ratio – Profit Volume Ratio may be expressed as:-

P/V Ratio = (Sales – Marginal Cost of Sales )/ Sales

Or = Contribution/ Sales.

Or = Change in contribution/ Change in Sale

Or = Change in Profit/ Change in Sale

Suppose the sale price and marginal cost of a product are Rs20 and Rs 12 respectively, The P/V Ratio will be (Rs 20-Rs12) X100 = 40%

P/V Ratio remains constant at different levels of operation. A Change in fixed cost does not result in change in P/V ratio since P/V expresses relationship between contribution and sales.

Advantages of P/V Ratio –

i) It helps in determining the break even point.

ii) It helps in determining profit at various sales levels.

iii) It helps to fins out the sales volumes to earn a desired quamtum of profit.

iv) It helps to dertermine relative profitability of different products, processes and deoartments.

Limitations of P/V Ratio-

i) P/V Ratio heavily leans on excess of revenue over variable cost.

ii) The P/V Ratio fails to take in to consideration the capital outlays required by the additional productive capacity and the additional fixed cost, tha t are added.

iii) Inspection of P/V ratio of products can suggest profitable product lines that might be emphasized and unprofitable lines that may be re-evaluated or eliminated. Mere inspection of P/V ratio will not help to take final decision. For this purpose, analysis has to be broadened to take in to consideration differential cost of the decision and opportunity cost etc, . Thus it indicates only the area to be probed.

iv) The P/V ratio has been referred to as the questionable device for decision-making because it only gives an indication of the profitability of the product/product lines: that too if other things are equal, P/V ratio is good for forming impression and not for making decision.

MARGINAL COSTING

Marginal Cost-

Definition- The cost of one unit of product or service that would be avoided if that unit were not produced or provided.

Marginal Costing –

The accounting system in which variable cost are charged to the cost units and fixed costs of the period are writing off in full against the aggregate contribution. Its special value is in decision-making.

Break Even Point- Break even point is the point of sale in which the company makes neither profit nor loss. The marginal costing technique is based on the idea that difference of sale and variable cost of sales provides for a fund which is referred to as contribution. Contribution provides for fixed cost and profit. At break even point, the contribution is just sufficient to provide for fixed cost. If actual sake level is above break even point, the company will make profit. If actual sale level is below break even point the company will incur loss. When cost volume profit relationship is presented graphically and it is the point at which total cost line and total sale line intersect each other will be the point of break even point.

Key Factor or Limiting Factor-

Key factor is the factor whose influence must be first ascertained to ensure that there is maximum utilization of resources. Gearing the production process in the light of key factor’s influences will lead to maximization of profits. Key factor contains managerial action and limits output of the company. Generally sale is the limiting factor, but any of the following factors can be limiting factor.

a) Materials

b) Labour

c) Plant & machinery

d) Power

e) Government action.

When a limiting factor is in operation and a decision is to be taken regarding relative profitability of different products, contribution for each products is divided by key factor to select the most profitable alternative.

Budget Committee

Budget Committee- The responsibility fo the preparation of budgets generally rests with the budget committee which generally includes the following executives:-

i) Chief Executive who will be the chairman of the committee.

ii) Production Manager

iii) Sales Manager

iv) Materials manager

v) Standard & Quality Control Manager

vi) Finance Manager

vii) Other Departmental Head.

Functions of Budget Committee-

The main functions are as follows-

i) Assisting the manager in making budget by giving them information about past performances,

ii) Circulating the broad outline of the policies framed by the top management which should be taken under consideration while preparing the budgets.

iii) Reviewing the budget estimate prepared by the various departments and suggesting modifications if necessary.

iv) Preparing the master budget after the functional budgets are prepared.

v) Comparing the reports of actual performances with budget policies and procedure.

vi) Assisting the preparation of budget manual.

Budget Manual- It is a document that contains the guidelines for the preparation of various budgets and sets out the responsibilities of the persons engaged in the routine of and the forms and records required for budgetary control. All departments refer this manual for clarification regarding procedural details and formats to be used at every stage from preparation of budgets till reporting of actual and deviations from budgets.

Budget Variance- A budget variance represents the difference between plan and achievements expressed in monetary terms, that is the difference between budget figure and actual figure. Variance analysis is the process of ascertaining variances from budget and finding reasons for variances. Variance is unfavorable if actual is more than budget. The same is favorable if actual is less than budget. Variance report is prepared showing budget and variances and sent to persons responsible for each functional budgets for comments and action. When standard costing is employed along with a system of flexible budgeting variance analysis is greatly facilitated.

Objectives of Budgetary Control

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Objectives of Budgetary Control-
a) Planning- To achieve its goal, an enterprise must plan what it must do and how it will reach the goal. In the processes of assessing the factors that will help reaching the goals, the enterprise should also anticipate problems that would make the process of reaching its goals difficult. Having identified some of these problems, it can decide well in advance how it would overcome them, if and when they came up.
b) Coordination- This involves proper balancing of all factors and coordinating the efforts put together by various departments and persons to reach the goals of the enterprise. If they do not work in synchronized manner, the organization will never be able to reach its goals.
c) Control- It is a process of keeping watch over actions and taking immediate planned action at the first signs of deviation from the planned course of action. In this way, events are compelled or directed to confirm the plans.
Types of Budgets-
Generally a master budget is prepared which in turn, is broken in to functional budgets. Budgets may be classified as follows-
i) Basic Budget & Current Budget.
ii) Fixed budget a& Flexible budget.
iii) Master budget & Functional Budget.
Basic Budget-
Basic Budget is based on a long term plan and is used on a long term plan and is used as a basis for developing current budget. A basic budget is much broader in scope and less detailed than a current budget. It may be fixed or flexible. The basic data are not updated whenever there are change in conditions such as increase in material price or wage rates. As a result, the use of basic budgets gives rise to operating variances. That is why for control purposes current budgets are more useful.

Current Budget- It is established for use over a short period of times usually one year but sometimes even less and related to current conditions that is average conditions which are likely to prevail during the budget period.

Fixed Budget- A fixed budget is designed to remain unchanged irrespective of the volume of output or turnover attained. The budget remains fixed over a given period and does not change with the change in the volume of production or level of activity attained . Normally, such a budget is prepared in respect of expenses of a fixed nature. As such this budget is of limited application.
Flexible Budget- A flexible budget by recognizing the difference in behaviour between fixed and variable costs in relation to fluctuation in output or turnover is designed to change appropriately with such fluctuations. A flexible budget changes according o the level of activity.
It is the results of two factors, a) the passage of time and b) the productive activity. The concept of cost variability gives rise to three categories of costs such as –
i) Fixed cost
ii) Variable cost
iii) Semivariable cost
Fixed cost does not vary with the volume or production activity but accrue with the passage of time. They are time or period cost. They remain constant over a period of time irrespective of the volume or level of activity. Variable cost vary in proportion to the volume of activity. They accrue as a result of efforts, activity or work done. They are product cost. They would not arise if there are no activity. Semi variable costs contain elements of both fixed and variable costs.
Master Budget- A Master Budget is prepared from and summaries, the various functional budgets. It is also called summary budget. It is a summary plan of the overall activities of the enterprise for a definite period. It generally includes details relating to production , sales, stocks, debtors, cash position, fixed assets etc, in addition to important control ratios.
The Master Budget embraces both operating decisions and financial decisions. When all budgets are ready they can finally produce budgeted profit & Loss A/C or incomes statement and budgeted balance sheet. Such results can be projected monthly, quarterly, half yearly and year end. When the budgeted profit falls short of the target it may be reviewed and all budgets may be reworked to reach the target or to achieve a revised target approved by the budget committee.



Functional Budget- It is a budget of income or expenditures appropriate to or the responsibilities of a function such as production, sales, purchase etc. Each functional department prepares its own budget and all these functional budgets are then integrated in to the master budget. The following functional budgets are generally prepared.
Budget Prepared by
Sale- Quantity & Value Sales Manager
Selling & Distribution Cost Sales MANAGER
Production- Units & plant Production manager
Utilization Personal Personnel Manager
Materials Purchase Manager
Factory Expenses Production Manager
Administrative Expenses Finance Manager
Cash Finance Manager
Capital Expenditure Chief Executive
Research & Development R & D manager

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BUDGETS AND BUDGETARY CONTROL

Management Accounting

Management Accounting – Concept, Need, Importance, and Scope, Cost Accounting: Classification of cost, Reconciliation of profit between financial and cost Accounting. Difference between Financial Accounting and cost Accounting.

Introduction – Cost accounting no doubt serves the internal management by directing their attention on inefficient operations and assisting in a day-to-day control of activities of the enterprise. But even costing information fails to meet informational needs for management functions. The costing data needs to be arranged, re-analyzed and processed further for playing more effective role in the managerial process. In addition to costing and accounting data, managerial functions need the use of socio-economic and statistical data( eg; population break up, income structures etc). These information’s are beyond the scope of cost accounting and financial accounting which pave the way for emergence of management accounting. Management accounting provides all possible information required for managerial purposes.

Management Accounting is comprised of two words ‘Management ‘ and ‘Accounting’ . it is the study of managerial aspect of accounting. The emphasis of management accounting is to redesign accounting in such a way that it is helpful to the management in formation of policy, control of execution and appreciation of effectiveness. It is that system of accounting which helps management in carrying out its function more effectively.

The term management accounting is of recent origin. This term was first used in 1950 by a team of accountants visiting USA under the banner of Anglo- American council on Productivity. The terminology of cost accountancy had no reference to the word management accountancy before the report of this study group. The complexities of business environment have necessitated the use of management accounting for planning, co-coordinating and controlling functions of management.

A small undertaking with a local character is generally \managed by him. The owner is in touch with day-to-day working of the enterprise and he plans and coordinate the activities himself. The use of simple accounting enables the preparation of profit & loss account and balance sheet for determining profitability and assessing financial position of the enterprise. All information needs for management purposes are met by simple financial statements. Since the owner is both the decisions- maker and implementer of such decisions, he does not feel the necessity of any communication system and no additional information is required for managerial purposes. The evolution of joint stock company form of organization has resulted in large-scale production and separation of ownership and management.

Is depreciation a source of funds

Depreciation means decrease in the value of an asset due to wear and tear, lapse of time, obsolescence, exhaustion and accident. Depreciation is taken as an operating expenses while calculating funds from operation. The accounting entries are as follows-

i) Depreciation A/C Dr

To Fixed Assets A/C

ii) Profit & Loss A/C Dr

To Depreciation A/C

Both the profit & loss A/C and depreciation are non-current asset and depreciation is an non fund item. It is neither a source nor an application of funds. It is added back to the operating profits to find out funds from operation since it has all been charged to profit & loss a/c bur it does not decrease fund from operations. Depreciation should not therefore be taken as source of funds. If depreciation were really a source of fund by itself then any enterprise would have improved its position at will by merely increase the periodical depreciation charge.

Fund flow statement Vs Income statement

1) It deals with financial resources required for running the business activities. It explains how were they used.	1) It discloses the results of the business activities i.e. how much has been earned and how it has been spent.
2) It matches the fund raised and fund applied during a particular period. The sources and applications of fund may be of capital as well as revenue nature.	2) It matches the income of a period with the expenditure of that period which are both of a revenue nature. For examples when shares are issued for cash, it becomes a sources of fund while preparing a fund flow statement but it is not an item of income for an income statement.
3) Sources of fund are many besides opearations such as shares capital , debentures, sale of fixed assets.	3) It discloses the results of operations can not even accurately tell about the funds from operations alone because of non-funds items (such as depreciation, writing off fictitious assets etc being included there in.

Fund flow statement Vs Balance Sheet

1).It depicts the overall increase or decrease in working capital during a particular period.	1) shows the financial position of a business on a particular date
2) It incorporates the different sources and applications of funds during a period.	2) It incorporates all assets and liabilities on a particular date .
3) It depicts the changes that have taken place in the fixed assets and fixed liabilities, which have a bearing on the funds during a particular period.	It shows all assets and liabilities of a business on a particular date.
4) It is a dynamic statement since it focuses on those major transactions, which have been behind the balance sheet changes.	4) It is merely a statement of assets and liabilities on a particular date.

Preparation of fund flow statement

However, the technique of cash flow statement when used in conjunction with ratio analysis serves as barometer in measuring the profitability and financial position of the business.

 

Preparation of fund flow statement

The preparation of fund flow statement has the following steps-

A) Schedule of changes in working capital-

B) FUND flow Statement

A) Schedule of hanges in Working Capital-

It can be prepared by comparing the current assets and current liability of two periods.

Items	As On	As On	Change
CURRENT ASSETS Cash Balance Bank Balance Marketable securities Accounts receivables Accounts receivables Stock-in-trades Prepaid expenses CURRENT LIABILTY Bank overdraft Outstanding expenses Account payable	Increase	Decrease
Net increase/ decrease in Working Capital

Rules for preparing the schedule-

i) An increase in current assets results in increase in working cpital.

ii) Decrease in current assets result in decrease in working capital

iii) Increase in a current liability results in decrease of working capital.

iv) Decrease in a current liabilities results in increase in working capital.

B) FUND FLOW STATEMENT

Source of Funds: Issue of shares Issue of debenture Long term borrowing Sale of fixed assets Operating profits Total sources Application of Funds- Redemption of redeemable preference shares Redemption of debentures Payment of other long term loans Purchase of Fixed Assets Operating Loss Payment of Dividends, Tax etc Total uses
Net increase/ Decrease in working capital ( Total Sources – Total Uses)

Utility of Cash Flow Analysis

A cash flow statement is useful for short term planning. A business enterprise needs sufficient cash to meet its various obligation in the near future such as payment for purchase of fixed assets, payment of debts maturing in the near future, expenses of the business etc.

i) It helps in efficient cash management – Cash is the basis for all operations and hence a projected cash flow statement will enable the management to plan and coordinate the financial operations properly. The management can know from which source it will be derived, how much can be generated internally and how much could be obtained from outside.

ii) It helps in internal financial management-It provides information about funds which will available from operation. This will help the management inn determining policies regarding the internal financial management eg, Possibility of repayment of long term debt, dividend policies, planning replacement of plant & machinery etc.

iii) Discloses the movement of cash- The increase in or decrease of cash and the reasons therefore can be known. It discloses the reasons for low cash balance in spite of heavy operating profit or for heavy cash balance in spite of low profit.

iv) Discloses success or failure of cash planning – The extent of success or failure of cash planning can be known by comparing the projected cash flow statement with the actual cash flow statement and necessary remedial measures can be taken.

 

Limitation of Cash flow analysis –

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1) Cash flow statement can nor be equated with the income statement. An income statement takes in to account cash as well as non-cash items and therefore net cash flow does not necessary mean net income of the business.

2) The cash balance as disclosed by the cash flow statement may not represent the real liquid position of the business since it can be easily influenced by postponing purchase and other payment.

3) Cash flow statement can not replace the income statement or fund flow statement. Each of them has a separate function .

However, the technique of cash flow statement when used in conjunction with ratio analysis serves as barometer in measuring the profitability and financial position of the business.

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Uses of Fund Flow statement

Uses of Fund Flow statement-

i) It explains the financial consequences of business operation. Funds flow statement provide a ready answer to so many conflicting situation such as ;

a) Why the liquid position of the business is becoming more and more unbalanced in spite of business making more and more profit ?

b) How was it possible to distribute dividends in excess of current earning or in the presence of a net loss for the period ?

c) How the business could have good liquid position in spite of business making losses or acquisition of fixed assets ?

d) Where have the profits gone ?

 

Defined answers to these questions will help the financial analyst in advising the employer/ client to direct the fund to the channels which will be most profitable for thee business.

ii) It answers intricate queries: - The financial analyst can find out answer to a number of intricate questions-

a) What is the overall credit worthiness of the enterprise?

b) What are the sources of repayment of loan taken?

c) How much funds are generated through normal business operation?

d) In what ways the management has utilized the fund in the past and what are going to be likely use of funds?

iii) It acts as instruments for allocation of resources. - A projected fund flow statement will help the analyst in finding out how the management is going to allocate scarce resources for meeting the productive requirement of business. The funds should be managed in such a way that the business is in a position to make payment of interest and loan installments as per the agreed schedule.

iv) It is a test as to effective or otherwise use of working capital- The adequacy or inadequacy of working capital will tell the financial analyst about the possible steps that the management should take for effective use of surplus working capital or more arrangement in case of inadequacy of working capital.

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FUND FLOW ANALYSIS

Meaning –The most commonly accepted meaning of the term fund is the working capital of the business which denotes excess of current assets over current liability.

There will be a flow of fund in case the working capital position of the company changes on account of any transaction.

Example -I- The company realizes Rs20000/- from its debtors. The transaction will reduce the debtors from Rs80000 to 60000 but increase the cash balance from the present balance of Rs 20000 to Rs40000. Thus the total current assets continue at the old figure of Rs 30000 . This means this transaction will not bring any change in the working capital of the company. It is simply a conversion of current assets in to another current asset.

Thus there is no flow of fund.

Example-II- The company sells its building having a book value of Rs50000 at sum of Rs 60000. This transaction will cash balance with the company from Rs20000 to Rs80000.The total current assets will be increased by Rs60000. Thus the transaction has brought a change in working capital position .

From the above, the following general rules can be formed –

1) There will be flow of fund if a transaction involves-

i) Current assets & fixed assets .eg. purchase of building for cash.

ii) Current assets and capital eg. Issue of share for cash

iii) Current assets and fixed liability.,eg. Redemption of debenture for cash.

iv) Current liability & fixed liability eg. Creditors paid up in debentures.

v) Current liability & capital eg. Creditors paid of in shares.

vi) Current liability and fixed assets. eg: Building transferred to creditors in satisfaction of their claims.

There will be no flow of funds if a transaction involves –

i) Current asset and current liability eg. Payment made to creditors.

ii) Fixed asset and fixed liability eg. Building purchased and payment made in creditors

iii) Fixed asset and capital eg. Building purchased and payment made in shares.

Cash Flow Analysis Vs Fund Flow Analysis

1) It is concerned only with the change in cash position.	1) It is concerned with the change in working capital position between two balance sheet dates.
2) A cash flow statement is mere a record of cash receipt and disbursement. Of course it is valuable in its own ways but it fails to bring to light many important changes involving the disposition of sources.	2) While studying the short term solvency of a business one is interested not only in cash balance but also in the assets which can be converted in to cash. This information is available in the fund flow statement.
3) It is more useful to the management as a tool of financial analysis in short period as compared to funds flow anlysis. It has rightly been said that shorter the period covered by the analysis, greater is the importance of cash flow analysis.	3) If it is to be found out whether the business can meet its obligations maturing after 10years from now, a good estimate can be made about firm’s capacity to meet its long term obligations if change in working capital on account of operation are observed.
4) Cash is apart of working capital and therefore an improvement of cash position results in improvement in the fund position, but the reverse is not true.	Inflow of cash result in inflow of funds but inflow of funds may not necessarily result in inflow of cash. Thus a sound fund position does not necessarily mean a sound cash position but a sound cash position generally mean a sound fund position.

Some people use the term fund in a very narrow sense of cash only . In such a event the two terms fund and cash will have synonymous meaning. For All You Blogs

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