Classification of Cash flows

04/02/2024 0 By indiafreenotes

Cash flows refer to the inflows and outflows of cash and cash equivalents in a business. These movements of money are essential for assessing the operational efficiency, financial health, and liquidity of an organization. Cash flows are categorized into three main activities: Operating activities, which involve cash related to daily business operations; Investing activities, which include transactions for acquiring or disposing of long-term assets; and Financing activities, which involve changes in equity and borrowings. Understanding cash flows is crucial for stakeholders to evaluate a company’s ability to generate positive cash flow, maintain and expand operations, meet financial obligations, and provide returns to investors. A detailed record of cash flows is presented in the Cash Flow Statement, a core component of a company’s financial statements.

Classification of cash flows within the Cash Flow Statement organizes cash transactions into three main categories, each reflecting a different aspect of the company’s financial activities. This categorization helps users understand the sources and uses of cash, offering insights into a company’s operational efficiency, investment decisions, and financing strategy.

Operating Activities:

Operating activities relate to the principal revenue-producing activities of the company and other activities that are not investing or financing activities. Cash flows from operating activities:

  • Receipts from the sale of goods or the rendering of services.
  • Payments to suppliers for goods and services.
  • Payments to and on behalf of employees.
  • Receipts and payments from contracts held for dealing or trading purposes.
  • Payments or refunds of income taxes unless they can be specifically identified with financing or investing activities.

Operating activities essentially focus on the cash inflows and outflows from the company’s core business operations, including any changes in working capital.

Investing Activities:

Investing activities involve the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Examples of cash flows arising from investing activities are:

  • Payments to acquire property, plant, and equipment (PPE), intangibles, and other long-term assets.
  • Receipts from the sale of PPE, intangibles, and other long-term assets.
  • Payments to acquire or proceeds from the disposal of shares, warrants, or debt instruments of other entities and interests in joint ventures (except for those considered cash equivalents or those held for dealing or trading purposes).
  • Advances and loans made to other parties (except those made by a financial institution where it is part of operating activities) and receipts from the repayment of advances and loans.

Investing activities reveal how much a company is spending on assets that it expects will generate future income and cash flows.

Financing Activities:

Financing activities include transactions resulting in changes in the size and composition of the contributed equity and borrowings of the entity. Cash flows from financing activities are:

  • Proceeds from issuing shares or other equity instruments.
  • Payments to owners to acquire or redeem the company’s shares.
  • Proceeds from issuing debentures, loans, notes, bonds, and other short or long-term borrowings.
  • Repayments of amounts borrowed.
  • Payments of dividends or other distributions to owners.

Financing activities show how a company finances its operations and growth through raising capital, repaying creditors, and paying dividends.