Flow of funds (FOF), also known as the "sources and uses of funds, are financial accounts that are used to track the net inflows and outflows of money to and from various sectors of a national economy. This article will provide an overview of the flow of funds, its importance, and how it is used to analyse economic activity.
What is Flow of Funds (FOF)?
The flow of funds refers to the net movement of cash into or out of different financial assets. It is calculated by evaluating the inflows and outflows of funds from various sources, such as investor payments or payments made to companies in exchange for goods and services. The flow of funds is typically measured on a monthly or quarterly basis and does not account for the output of an asset or fund. It is centred on cash movement, indicating the net movement after evaluating monetary fund inflows and outflows.
How does the flow of funds work?
The flow of funds is a detailed economic framework that tracks how money moves between different sectors of the economy—like households, businesses, governments, and the rest of the world. It monitors who is borrowing, who is lending, and how financial assets like loans, deposits, and investments are created, transferred, or extinguished.
At its core, this system captures two main types of data:
- Flows: These reflect movement—money being lent, invested, or spent.
- Stocks or positions: These show how much money or value is held at a particular point in time, like a financial snapshot.
Central banks and statistical agencies typically compile this data. They categorise it by sectors and asset types (e.g. cash, loans, debt securities, credit), and present it in a structure similar to balance sheets. This gives economists a clear picture of who owns what and who owes whom.
Why does it matter? Because analysing the flow of funds helps policymakers understand which sectors are over-leveraged, where credit growth is happening, and how dependent an economy is on external funding. It's crucial for making informed decisions on monetary policy, fiscal planning, and financial regulation.
Flow of fund matrix
The flow of funds matrix represents the financial flows within an economy, highlighting six key economic sectors. These sectors are:
- Households
- Non-profit organisations
- Corporations
- Farms
- Government at all levels
- Central
- State
- Local
- Foreign sector
Also read: Income Tax Slab for FY 2024-25
Flow of funds example
A few examples of financial instruments accounted for by the flow of funds account include:
- Treasury assets
- Fund deposits abroad
- Savings deposits
- Money market funds
- Bonds
- Corporate equities
- Pension funds
- Consumer credits
- Mortgages
- Mutual funds
Flow of funds accounts track the change of assets and liabilities in all the listed sectors. While “uses” include expenses and lending, “sources” include all the generated income and sectoral borrowings. That’s why the sources are related to changes in assets. Assets, on the other hand, are related to liability changes.
To understand the health of an economy, the central bank of a country gathers the FOF data and compares it against that of the previous year. In fact, the flow of funds data is used by policymakers and governments to make monetary policy strategies.
Also read about: What is the cash ratio?
How to understand the flow of funds?
There are multiple entities in an economy, such as households, government, corporations, and firms. The flow of funds in an economy works through a complex transaction network and interactions among an economy’s multifaceted entities.
Generally, the flow of funds works in the following way:
1. Generation of funds
Generation of funds takes place through various activities such as:
- Income from employment
- Business profits
- Investments
- Government revenue earned from taxes and fees
2. Allocation and distribution
The generated funds are then allocated and distributed among different sectors as well as entities.
Individuals allocate these funds to:
- Consumption
- Savings
- Investments
Businesses allocate funds to:
- Operating expenses
- Capital investment
- Debt servicing
Governments allocate funds towards:
- Public services
- Infrastructure
- Debt repayment
3. Intermediation
The financial institutions collect money saved or invested by the individuals. They, in turn, use various financial instruments such as investments and loans to channel funds to borrowers.
4. Investment and consumption
The businesses then use funds for investing in:
- Infrastructural development
- Purchase of financial assets
- Expansion of businesses
Households and businesses use funds for consumption purposes. It includes spending on goods and services.
5. Reinvestment and redistribution
Investments and other economic activities generate returns. They are reinvested or redistributed, which, in turn, helps in further economic growth and wealth accumulation. Government spending, wages, and dividends make redistributed funds flow back into the economy.
6. Monitoring and regulation
The flow of funds is monitored regularly by the central bank of a country, regulatory bodies, and governments. Once they strategise on the basis of FOF data, they implement effective policies to support sustainable growth and stability.
Also read: What is expense ratio?
Limitations of the flow of funds accounts
The detailed recording of financial transactions between sectors makes it hard to analyse and more complicated.
- It doesn't include the flow of human capital.
- It's challenging to record assets, obligations, and claims without a fixed value.
- Despite these drawbacks, the flow of funds approach is a great tool for assessing a nation's economic performance and understanding its financial status across different sectors.
Key takeaways
- Flow of funds (FOF) refers to national financial accounts that trace how money moves between different sectors of the economy—like households, corporations, governments, and foreign entities.
These figures are usually compiled by the central bank and provide a clear view of borrowing, lending, investments, and financial assets across the economy.
Flow of funds analysis is essential for economic forecasting, as it helps assess financial stability, predict GDP trends, and shape informed fiscal and monetary policies
Summary
The framework of the flow of funds (FOF) has limitations too. Behavioural assumptions, quality, and data aggregation are some of the common problems. To understand economic dynamics and risks, you must supplement the flow of funds analysis with other indicators and qualitative insights.
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