What You Should Know about Operating Activities

Operating activities are the tasks and duties a business has to perform on an ongoing basis to earn an income. They are the core activities of a business and as a result, they affect the cash flow coming in and out, and determine the business’ net income. 

In today’s article, we’ll discuss the types of operating activities, what to include in operating activities, and how operating activities and the cash flow statement are related. 

What are the types of operating activities?

Operating activities are directly associated with a business’s various functions, such as manufacturing, selling, marketing, etc. Here are the types of operating activities:

Revenue-generating activities: Generating revenue is one of  the chief goals of a business; therefore, the majority of business activities are activities that produce income. There are two primary activities that bring revenue to the business: selling products and providing services.

Marketing and advertising activities: These types of activities refer to your business’ actions regarding the promotion and advertising of goods and services. For example, you could hire a graphic designer to create promotional labels or packages. Or, if you want to push the promotions of your products, you’d need to hire a digital marketer to run a new ad campaign. 

Administration activities: Administrative activities are tasks related to maintaining a business. These duties vary widely from workplace to workplace but most often include tasks such as purchasing materials, human resources, and basic accounting. 

Maintenance activities: Maintenance activities are carried out regularly in order to keep your office neat, tidy, and functional. These activities include cleaning, visual inspection, functional tests, lubrication, measurement of operating quantities, and oil tests. 

Customer service activities: Customer service is important to any business as it solidifies the relationship between you and your customers, which results in greater loyalty and more sales. Customer service activities include the support you provide via email, web, text message, and social media. 

What to include in operating activities?

Operating activities are directly associated with a business’ principal goal: to sell its products or services. Through operating activities, businesses are able to generate income and make a profit. Therefore, these activities relate to transactions that affect net income.

The operating activities that result in cash inflows are:

  • Cash receipts from sales
  • Sales of shares
  • Income earned from investment
  • Settlements of lawsuits and insurance claims
  • Collection of accounts receivable
  • Supplier refunds

The operating activities that result in cash outflows are:

  • Employee payments
  • Supplier payments
  • Tax payments
  • Refunds to customers
  • Settlements of fines and lawsuits
  • Interest to creditors
  • Equipment purchase
  • Interest payment on loans and dividends

Operating activities and the cash flow statement

The cash flows from operating activities are one of the most important elements of the cash flow statement. Cash from operating activities is the money generated from the business’ core operations. It is distinct from the cash flows derived from investing and financing activities. 

In contrast to cash from operating activities, cash from investing activities comes from sales and purchase of equipment and assets (tangible or intangible) and other capital expenditures. Cash from financing activities is the money your business gains from the procurement and repayment of short and long-term debt, issuance of equity, purchase/sale of treasury stock, payment of dividends, etc.

The cash flow can be either positive or negative. Having a positive cash flow is a good sign meaning that your business is thriving. On the other hand, having a negative cash flow might indicate that your business is facing trouble. To get an accurate picture of a company’s cash flow from operating activities, accountants add depreciation charges, losses, decreases in current assets, and increases in current liabilities to net income. 

Business managers, owners, and investors review a company’s cash flow from operating activities separately from the other two components of cash flow to see the true source of a company’s money. A positive cash flow from operating activities for a continuous period means the company is going in the right direction and thriving. This is more important than a positive cash flow from investing or financing activities, which are one-time gains from selling assets or stocks. 

Read also: What You Need to Know about Operating Cash Flow Ratio

The bottom line

Operating activities are the business’ core activities to generate income. Operating activities result in operating activities cash flow, the most important element of the cash flow statement.

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What Is a Cash Flow Statement and Why Is It Important to a Business?

As a manager or business owner, it’s important to know whether or not your business is making a profit. For this, most people usually refer to their income statements. But having a profit doesn’t necessarily mean you have enough cash on hand to pay for immediate expenses.

That’s when the cash flow statement comes in. A cash flow statement is a powerful tool to track your business’s cash inflows and outflows. In addition, it lets you know the money that is available for your business at a certain time. In today’s article, we’ll walk you through the most essential things you need to know about a cash flow statement. 

What is a cash flow statement?

The cash flow statement is a financial statement that outlines the amount of cash and cash equivalents entering and leaving a business in a given period of time. It’s one of the three most important financial documents, along with the income statement and balance sheet.

Much like the income statement, the cash flow statement measures a company’s performance over a given time. However, while income statements are helpful in determining your company earnings, spending, and profitability, they don’t always indicate how much cash you have on hand.

Instead, the cash flow statement adds adjustments to the data on the income statement, so you can see your net cash flow—the exact amount of cash you have on hand for that period.

For example, a depreciation expense, which is recorded as a monthly expense on the income statement, doesn’t have an actual cash outflow associated with it. It’s basically an allocation of the cost of an asset over its useful life. You’ve already paid for the asset you’re depreciating. Now you’re just keeping track of it on a monthly basis to see how much it costs you each month. Each business has some flexibility in selecting its depreciation method, which affects the depreciation expense reported on the income statement.

Read also: What’s Net Cash Flow and How Do You Use It?

Structure of a cash flow statement

The three main sections of the cash flow statement are cash from operating activities, investing activities, and financing activities. 

Cash from operating activities: This source denotes how much money a company makes from its core operations. 

These operating activities might include:

  • Receipts from sales of goods and services
  • Interest payments
  • Income tax payments
  • Payments made to suppliers of goods and services used in production
  • Salary and wage payments to employees
  • Rent payments
  • Any other type of operating expenses

Cash from investing activities: This is the cash generated from the sales and purchases of equipment and assets (tangible or intangible), loans paid to suppliers or received from consumers, and any payments related to a merger or acquisition. In a nutshell, changes in equipment, assets, or investments are related to the cash generated by investing activities. 

Cash from financing activities: This type of cash comes from investors or banks, as well as the uses of cash delivered to shareholders. Short and long-term debt, issuance of equity, purchase/sale of treasury stock, payment of dividends, etc., are included in this category. 

How do you calculate cash flow?

There are two formulas to calculate your cash flow: the direct method and the indirect method.

The direct method

The direct method for calculating cash flow is based on cash accounting information. This method measures the funds that come in, mainly from sales, and the money that goes out, which are usually payments to suppliers. Thanks to its simplicity, small companies often use this method to calculate their cash flow.

The indirect method

In contrast to small businesses, big companies adopt accrual accounting as their main accounting method. Under accrual accounting, transactions are recorded when they are incurred rather than awaiting payment. This means a purchase or expense is recorded as a transaction even though the funds are not received or bills are not paid immediately.

This causes a mismatch between net income and actual cash flow because not all transactions on the income statement involve actual cash items (for example, depreciation expenses). Therefore, some elements must be re-evaluated regarding cash flow from operations. With the indirect method, cash flow is calculated by adding or subtracting non-cash transactions from net income. 

You may be also interested in: What You Need to Know about Operating Cash Flow Ratio

Why do you need the cash flow statement?

1. It shows your liquidity

The cash flow statement lets you know how much money you have at a specific time. As a result, in case you need to purchase an asset, you’ll know what you can afford and what you can’t.

2. It gives insight into spending activities

If you want to know how your company is spending and where your money is going, look at the cash flow statement. Cash flow statements provide a comprehensive view of a company’s payments that aren’t shown in a profit and loss statement. For example, if your business took out a loan and is paying it back, those payments will not appear on your profit and loss statement.

3. It helps you with short-term planning

When it comes to short-term planning, cash flow statements are very valuable. Using the cash flow statement, managers can predict cash flow in the near future and keep track of expenditures to accomplish particular, short-term goals. 

4. It suggests ways to increase cash inflow capability

When it comes to increasing a business’s cash inflows, people often think of generating higher revenue. But it isn’t the only option. You can improve your cash inflow by “adjusting” some expenses. For example, if a company’s employees discover that they are spending a lot of money on inventory, they could find ways to efficiently use inventory to collect receivables faster.

The bottom line

The cash flow statement is one of the three key reports, along with the income statement and balance sheet, used to determine a company’s success. The cash flow statement tracks your business’s cash inflows and outflows in a given time. 

If you’re interested in entrepreneurship stories, business tips, or productivity tools, find more posts like this on Shoeboxed. Shoeboxed is a cloud-based software that helps businesses turn their massive paper receipts into digital data. With Shoeboxed, you can do many things: scan, store and organize receipts, manage business expenses, store business cards and even track mileage for business travelers. It’s simple to install and easy to use.