Understanding the Flow of Funds: Why it Matters for Your Audits and Financials

If you work in a government finance office—especially in a school district, city, or special district—you’ve probably heard terms like “fund accounting,” “restricted funds,” or “interfund transfers” thrown around during budget season or audit prep.

But when it comes time for the audit or preparing financial statements, many teams still run into the same problems:

• The trial balance doesn’t match fund-level reports

• Fund balances look off from last year

• Auditors ask questions no one can answer confidently

In almost every case, the root issue is a lack of clarity around one key concept:

 

How funds actually flow through your organization.

Here’s why understanding the flow of funds matters—and how to improve the way your team tracks and communicates it for audit success and better financial reporting.

What Is “Flow of Funds” in Government Accounting?

In government entities, money isn’t managed in one big pot. Instead, it’s divided into funds—each with its own purpose, restrictions, and reporting requirements.

The “flow of funds” refers to how money moves:

• Into each fund (revenue and transfers in)

• Out of each fund (expenditures and transfers out)

• Between funds (interfund activity)

• Over time (ending balances rolling forward)

It’s not just about where the money goes—it’s about why it’s in a particular fund, what rules govern it, and how it affects your entity’s financial health.

Why It Matters for Your Audit

Auditors don’t just test balances—they test the story behind them. And the flow of funds is one of the key areas where that story either makes sense… or causes issues.

Here’s how poor fund tracking can show up during your audit:

• Missing or unsupported interfund transfers

• Negative fund balances that weren’t explained or addressed

• Restricted funds used for ineligible purposes

• Fund revenues not aligning with budgeted activity or grant requirements

And if you can’t clearly explain how money flowed into, out of, or between funds?
It raises red flags.

Why It Matters for Your Financial Statements

GASB standards require financial statements to reflect the fund-level activity clearly and accurately. That means:

• Major governmental funds are reported individually

• All other governmental funds are aggregated

• The government-wide statements report full accrual balances, including reconciliations from fund-level results

If you don’t understand the flow of funds:

• Your financial statements may misstate fund balances

• Your note disclosures may miss key restrictions or transfers

• Your budget-to-actual schedules may confuse stakeholders

• You may end up with audit findings that affect public trust

How to Get a Better Handle on Fund Flows

You don’t have to be a CPA to understand how funds flow—you just need the right tools and habits. Here’s where to start:

✅ 1. Use Clear, Consistent Fund Names and Numbers

Make it easy to trace activity by labeling funds in a way that makes sense and is consistent year over year.

✅ 2. Track Transfers Separately from Revenues and Expenses

Keep a log of every transfer between funds—why it occurred, who approved it, and how it was recorded. Be clear whether it was a routine operating transfer or a one-time reallocation.

✅ 3. Reconcile Fund Balances Monthly

Monitor your fund balances as part of your regular close process. Don’t wait until year-end to discover a deficit or unexplained variance.

✅ 4. Document Restrictions and Purpose Codes

If a fund is restricted (grants, debt service, capital projects), keep supporting documentation that explains what the money can be used for—and confirm that it’s being used correctly.

✅ 5. Review Prior-Year Statements for Consistency

Use your prior audit report or AFR as a guide. Compare fund activity to last year’s disclosures and confirm that current-year activity lines up with expectations—or document why it changed.

Fund Flows Tell the Story of Your Finances

Every fund in your accounting system represents a promise—how money was meant to be used, tracked, and reported.

Understanding how funds flow through your organization is essential to telling that story clearly—to auditors, board members, and the public.

✅ It makes your audit faster and smoother
✅ It makes your financial statements more accurate
✅ It protects your entity from misstatements or findings
✅ It builds confidence in your team’s ability to manage public dollars well

Start simple. Track what comes in. Track what goes out. And connect the dots.

Because when you understand the flow of funds—you understand the financial health of your entire organization.