Sources of Funds

Overview

Sources of funds refer to the various ways through which businesses acquire capital necessary for their operations and growth. These are listed in the statement of changes in financial position, showing the increase in funds over an accounting period. Funds are often defined as working capital (current assets minus current liabilities) or cash.

Definitions and Key Components

Working Capital:
- Formula: Current Assets - Current Liabilities
- Sources of Working Capital:
  1. Working Capital Provided from Operations: This includes net income plus non-working capital expenses minus non-working capital revenue.
  2. Decrease in Noncurrent Assets: Selling fixed assets like buildings or machinery.
  3. Increase in Noncurrent Liabilities: Taking on long-term debt such as bonds or long-term loans.
  4. Increase in Stockholders’ Equity: Issuing new shares or retaining earnings.
Cash: When funds are explicitly defined as cash rather than working capital, additional sources include:
- Decrease in Current Assets Other than Cash: Selling inventory or collecting receivables.
- Increase in Current Liabilities: Utilizing short-term credits like accounts payable.

Examples

Decrease in Noncurrent Assets:
- A company sells a piece of manufacturing equipment for cash, decreasing noncurrent assets and providing cash as a source of funds.
Increase in Noncurrent Liabilities:
- A business takes out a 10-year loan from a bank, increasing noncurrent liabilities and providing additional working capital.
Increase in Stockholders’ Equity:
- A firm issues new shares of stock, thus increasing stockholders’ equity and bringing in fresh capital.
Decrease in Current Assets Other than Cash:
- An organization collects a significant amount of receivables, converting them into cash, thereby providing funds when cash is the defined metric.
Increase in Current Liabilities:
- A company delays payments to suppliers, increasing accounts payable, thus temporarily boosting their cash position.

Frequently Asked Questions (FAQs)

Q1: What is the primary difference between working capital and cash?

A1: Working capital measures a company’s operational efficiency and liquidity, defined as current assets minus current liabilities. Cash is a specific asset within current assets and represents only the liquid aspect of working capital.

Q2: Why are sources of funds important in business accounting?

A2: They indicate how a business acquires the capital needed for its operations and growth, providing insights into its financial strategy and stability.

Q3: Can a decrease in inventory be considered a source of funds?

A3: Yes, when funds are defined as cash, selling inventory decreases current assets (other than cash) and increases cash, thus serving as a source of funds.

Q4: What role do noncurrent liabilities play in the sources of funds?

A4: Increasing noncurrent liabilities, such as acquiring long-term loans, provides additional working capital or cash, helping finance long-term projects and investments.

Q5: How do changes in stockholders’ equity affect funds?

A5: Issuing new stock or retaining earnings leads to an increase in stockholders’ equity, providing the business with more capital.

Working Capital: The available capital for day-to-day operations of a business.
Noncurrent Assets: Long-term investments or physical assets not expected to be converted into cash within a year.
Noncurrent Liabilities: Long-term financial obligations not due within the next 12 months.
Stockholders’ Equity: The residual interest in the assets of the entity after deducting liabilities.

Online References and Resources

Suggested Books for Further Studies

“Financial Accounting” by Walter T. Harrison Jr. and Charles T. Horngren
“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
“Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen

Sources of Funds: Accounting Basics Quiz

### What does the term 'working capital' refer to? - [x] Current Assets minus Current Liabilities - [ ] Total Assets - [ ] Total Liabilities minus Current Assets - [ ] Net Income minus Expenses > **Explanation:** Working capital is calculated as current assets minus current liabilities, reflecting a company's short-term liquidity. ### What is a primary source of working capital in business operations? - [ ] Decrease in Noncurrent Liabilities - [ ] Increase in Inventory - [x] Working Capital Provided from Operations - [ ] Decrease in Cash Reserves > **Explanation:** Working capital provided from operations typically involves net income plus non-working capital expenses less non-working capital revenue. ### How can a decrease in noncurrent assets result in an increased source of funds? - [ ] By generating revenue - [ ] By increasing liabilities - [x] By selling long-term assets for cash - [ ] By distributing dividends > **Explanation:** Selling noncurrent assets like property or equipment converts these assets into cash, thereby increasing available funds. ### What results in an increase in stockholders' equity? - [ ] Decrease in Stock Prices - [ ] Cash Expenditures - [x] Issuing New Shares - [ ] Taking Short-term Loans > **Explanation:** Issuing new shares increases stockholders' equity by bringing additional capital into the business. ### What happens when a company increases its current liabilities, such as accounts payable? - [x] It provides more cash since payments are delayed - [ ] It increases cash outflow immediately - [ ] It increases earnings per share - [ ] It provides tax deductions > **Explanation:** Increasing current liabilities like accounts payable delays cash outflows, temporarily boosting the company's cash position. ### When funds are defined as cash, what additional source can be used aside from working capital? - [ ] Decrease in Revenue - [x] Decrease in Current Assets Other Than Cash - [ ] Increase in Total Liabilities - [ ] Increase in Fixed Assets > **Explanation:** When considered as cash, selling off current assets other than cash (like inventories or receivables) can provide additional funds. ### How does issuing new stock affect a company’s funds? - [ ] It reduces available working capital - [x] It increases stockholders' equity and available funds - [ ] It decreases overall revenue - [ ] It affects the company's liabilities > **Explanation:** Issuing new stock increases stockholders' equity and brings new capital into the company. ### Which of the following is not typically considered a source of funds? - [ ] Decrease in Current Assets - [ ] Increase in Noncurrent Liabilities - [ ] Increase in Stockholders' Equity - [x] Payment of Dividends > **Explanation:** Payment of dividends is a distribution of profits to shareholders, not a source of funds. ### What is the primary purpose of identifying sources of funds on financial statements? - [ ] To determine tax liabilities - [ ] To measure depreciation - [ ] To negotiate salaries - [x] To display how funds were acquired during the period > **Explanation:** The primary purpose is to show how the business acquired additional funds during the period for operations and growth. ### What qualifies as working capital provided from operations? - [x] Net income plus non-working capital expenses minus non-working capital revenue - [ ] Net income minus current liabilities - [ ] Total sales minus total expenses - [ ] Total assets minus total liabilities > **Explanation:** Working capital provided from operations includes net income adjusted for non-working capital expenses and revenue.

Thank you for exploring the various sources of funds in business accounting and challenging yourself with our quiz questions. Keep aiming for excellence in your financial knowledge!