What is Fund From Operations (FFO)?
Funds from operations is the difference between the inflow of funds in the form of expenses. The funds from operations are the largest sources of funds which are used for repayment of loans, purchase of assets, payment of dividends, taxes, etc.
The controversial point here is that an enterprise making a substantial profit may not have adequate funds at the end of the year/period or an enterprise may have enough funds at its disposal, but might have incurred substantial loss at the end of the year/period.
The attributed reason for this paradox is that, the profit and loss account records all expenses paid and outstanding and all incomes received and accrued. Further, charging of depreciation, amortization of intangible and fictitious assets do not require any use of funds in the current period. Rather, they simply reflect the apportionment of past expenses. It means, the profit and loss account does not differentiate between funds flow and non-funds flow items while calculating the net profit.
Note: Depreciation, goodwill written off, amortization of intangible assets like patents, writing off of discount on shares or/and debentures, writing off of preliminary expenses, etc. form the items of non-funds flow.
Calculation of Funds from Operations
For calculating funds from operations, any one of the following formats may be used. i.e., (1) profit and loss adjustment account (T format) or (2) statement format. [Note: There is no prescribed format. Use of a format is only a matter of convenience].
Profit and Loss Adjustment Account
Funds from operations can be calculated either in the account format or statement format. If it is presented in the form of an account, an adjusted profit and loss account is prepared. The account starts with opening balance of profit on the credit side and ends with closing balance of profit on the debit side (if there is a loss, opening balance appears on the debit side and the closing balance of loss on the credit side).
All non-Operating expenses are shown on the debit side and all non-operating incomes are shown on the credit side. If the debit side is more than the credit side, the difference is called funds from operation. On the contrary, if the credit side is more than the debit side, the difference is called funds lost in operation. The format of adjusted profit and loss account is shown as follows:
Profit and Loss (P/L) Adjustment Account
Note: Either funds from operations or funds lost in operations (any one item) will appear in the statement. Similarly, for opening and closing balances of profit and loss account (profit or loss).
If it is prepared in the statement form, the statement will start with closing balance of profit and loss account. All such expenses which do not result in an outflow of funds are added to the profit and all such incomes which do not result in an inflow of funds are deducted. If the profit given in profit and loss account is after making all appropriations, then the balance in profit and loss account at the beginning of the year must also be deducted to arrive at funds from operation. Pro forma to calculate funds from operation in statement form is given in the below example.
Statement Showing Funds from Operations
Formula to Calculate the Funds from Operations
From the following balances extracted from the books of Goods going Ltd. prepare funds from operations for the year 2020 in the account format as well as statement format:
Calculation of funds from operations
1. Account Format
Adjusted Profit and Loss Account
2. Statement Format
Statement Showing FFO