Sources and Uses of Funds
Sources and uses of funds refer to the process of providing and spending of funds. Businesses rely on different sources to provide the financial resources they require to operate. In other words, a business has to find sources that can fuel its activities so that it can make a profit. Understanding the flow of funds within an organization can help managers to track the results of their uses of funds. In addition, it allow them to make an informed decision about future fund allocations. This information is provided in a report called sources and applications of funds.
The sources and uses of funds statement provides additional information to the balance sheet. In general, the balance sheet provides a summary of business accounts at the end of a financial year, whereas this statement clarifies the changes that occurred within the accounts in compare to the previous year. To determine the sources and uses of funds, we go back to the basic accounting equation.
Assets = Liability + Owner’s equity
Liabilities and owner’s equity
Based on the structure of the balance sheet, liabilities and owner’s equity are place on the left and assets are located on the right side. Simply put, the accounts on the left side of the balance sheet are used by a business to acquire what it needs to operate. In addition, a company makes use of those sources to run its operations. Therefore, a company increases the equity or liability to provide the funds that allow it to buy assets, produce goods, or provide services. In contrast, if the capital or the liabilities decrease, they have been used.
For instance, a company may decide to increase its capital to fund a new project. It may also decide to ask for a loan, or delay payments to increase the cash deficit. Funds can be used for more than one activity. They can provide the means to pay old debts, pay off loans, buy assets, and fund a research. It is important for a business to know which activities are using the majority of the funds, and whether this is in alignment with company goals. Borrowing money from a bank without putting it to good use can only provide more debt for the business. Moreover, using loans to pay off debts rather than using it to improve operations and generate profit makes a significant difference to the business.
Assets as sources and uses of funds
Another way to provide funds is through selling assets. Contrary to equity and liability, assets have to be decreased so that funds can become available. Thus, the sources and uses of funds in the case of assets a completely the opposite. In this case, application of funds means buying or increasing assets, whereas sources of funds comes from selling or decreasing them.
For example, a building or a land not used as a location for business activities can be sold to fund a new development project or another investment that can generate a profit. On the other hand, the increase of inventories means increase of sources of funds because the goods can be sold to generate money for further activities.
Based on the explanation provided above, this statement requires the balance sheets of the current year as well as the previous one. The difference between the figures of each account indicates the amount of the use or source of funds. The nature of each account (asset, liability, or equity) determines whether it was a source or application of funds. In the end, the sum of sources and uses are equal, but the percentage of each indicates how and where funds were used. The analysis of this information helps business to prioritize their uses of funds in the future.
Look at how the sources and applications of funds are included in a business plan in the link below. Summarize the information into a 2 minute presentation.
Choose A or B.
- Choose a public company from the ones that offer their shares in the stock market. Find their last two balance sheets and determine their main sources and uses of funds.
- Use your company’s balance sheet information to provide a sources and uses of funds statement.