Flow of Funds

Flow of Funds (FOF) refers to the financial accounts used to monitor the movement of money into and out of different parts of a country's economy.
Flow of Funds (FOF)
3 min
24-June-2024

The flow of funds, also known as the "sources and uses of funds," is a comprehensive accounting framework that tracks the movement of financial resources within an 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 the 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.

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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

Example of Flow of funds

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.

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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Frequently asked questions

What do you mean by flow of funds?
The central bank of a country (such as the Reserve Bank of India) collects and analyses macroeconomic data. It helps RBI in tracking the inflows/outflows of money to/from a national economy’s various sectors. Flow of funds (FOF) is essentially financial accounts that enable central banks across the world to track the fund.
What are the types of fund flows?
Fund flows are of two types: positive fund flow and negative fund flow. When the inflow of capital is higher than the outflow, it is called positive fund flow. It shows that the confidence of investors is strong. In the case of negative FOF, the investors’ confidence is usually perceived as low.
Why is the flow of funds important?
The flow of funds is important because it helps either the central bank of a country or a company understand its payment risks and the efficacy of its business model. With a better understanding, companies can control their finances in a better manner. Therefore, they can formulate strategies better and make better financial planning for the long run.
What are the components of flow of fund?
The flow of funds has two essential components: source of funds and application of funds. While the source of funds highlights the sources from where the funds have come from, the application of funds shows how funds are utilised both in the long run and short run.
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Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.