Application of funds is the term used in the context of funds flow statement, in simple words application of funds refers to use of cash or funds by the company during a financial year on various activities of the company. In order to understand about application of funds in a better way let’s look at some of the examples of application of funds –
- The first and foremost example will increase in net working capital of the company because working capital is calculated as current asset less current liabilities. Now if working capital has increased then it implies either of two things that is either current asset has increased or current liabilities has decreased. If the current asset has increased then it implies that company has paid cash or use funds to acquire the current asset and it can be considered as the application of funds and if current liability has decreased then it means the company has paid cash to settle the liability which is again an application of funds.
- Another example is when company buyback its own equity shares or redeem debentures and preference shares. When company buyback shares it has to pay cash to equity holders which come under application of funds, same as the case when company redeems its preference shares or debentures because it involves repayment of capital in the form of cash to preference and debenture holders.
- Payment of dividend to equity and preference shareholders is another example of an application of funds as these payments are made in cash only.
- Payments of various taxes like income tax, sales tax, wealth tax and so on will be also come into the application of funds as these payments are also made in cash.
- When the company purchases fixed assets like land, building, plant and machinery and also make investments like purchasing shares of other company, making fixed deposits in banks, purchasing mutual funds and so on than these all will also be considered as an application of funds.
- The loss in business is also an example of the application of funds because any loss in the business of the company will result in a reduction in funds of the company.
As one can see from the above that application of funds basically means that situation where the cash or funds are moving out from the business, however, one should keep one thing in mind that shortage of funds does not necessarily mean that company is making a loss or it is in trouble, however, it warrants the attention of top management.