Operating Activities

Operating activities generate the majority of the cash flows for the company as it is directly linked to the core business activities of the company like sales, distribution, production, and so on; these activities also determine the profitability of the company and items categorized under this head are the primary revenue units of the company.

Operating activities are the core activities of any company like Sales, administration, marketing, and some other depending on the company's operations; this activity and the operating income assist us in analyzing any company from the investment or functional perspective.

Fundamental activities of a business that can directly affect the company's profitability and are mostly the primary unit of the company are classified as the operating activities. Additionally, maintenance and administrative activities also fall under the same head operating activities in accounting.

These activities can be found under the head of Operating activities in the financial statements like cash flow statement and income statement.

Other activities are found in these financial statements, namely Financing activities or Investing activities. They are not directly linked with the current profitability;  instead, they help the company function in the long haul.

Cash flows reflect the operating activities in cash flow statement which include the inflows and outflows from the operating activities in the company's financial statement, and after the expenses are deducted from the income, we get Operating Income.

Cash flows from operating activities may act as a financial parameter for analysts and investors to determine the company's functionality.

Operating cash flow can determine the capacity of the company to repay the current expenses like labor wages, administrative expenses, and many more.

The activities like sales, marketing, and customer service can be a part of operating activities. They help generate quarterly or annual revenue through which a company's cost-effectiveness can be determined. Let us try to understand the different types of the same.

It includes two sections Operating Revenue and Operating Expenses, through which we will get to operating income. Let us understand these two heads with the activities categorized under each of them;

#1 - Operating Expenses (Cash outflow) - The operating activities in cash flow statement can also be in the form of cash outflow like payments made to various parties like employees, suppliers, vendors, etc. Cah outfow can also be due to interest payment on loans, dividend payments to shareholders, etc. Payments can also be in the form of income tax or daily operating expenses incurred for running the business. They are listed below:

• Employee Salary Payments
• Interest expense to the creditors
• Interest on Loan and Dividends
• Taxes
• Lawsuit fine or fees for legal settlements
• Advertising Expenses

#2 - Operating Income (Cash Inflow) - The cash inflow can be in various forms. In can be in the form of revenue that is earned from sale of goods and services, the interest or dividend income from lending and investments in other organizations, any kind of intangible assets like patents, copyrights, intellectual property, etc. Cash inflow can come from other sources also like commissions and fees that are earned from advisory and financial services and also from real estates. Thus, they can be listed below.

• Cash Sales
• Investment Income
• Accounts Receivables
• Refunds from Suppliers
• Settlement of Insurance or legal lawsuit claims. 

#3- Research and Expansion - The business often need to use fund for the expansion and growth of the business. This operating activities in accounting can be in the cash spent on buying better and innovative products, hiring more labor for handling more jobs, or payment to contractors.

#4- Other operating activites- This will include any amount of cash generated due to profit or loss from disposing off long term assets. Sometimes the business also needs to put some cash aside for meeting unexpected expenses or bad debts that cannot be collected any more.

These are only some examples of the operating costs and revenue listed above; where after deducting the operating expense from the operating income, we can get to the Net Operating Revenue.

Let us see an example to understand the concept of business operating activities in an illustrative manner; below is the data available from its financial statements of Tesla. First, let us see what kind of operating activities a company like Tesla reports.

Solution

Step 1: Let us calculate Total funds from operation i.e Net Income + Depreciation, Depletion & amortization + Other funds which comes to -1063 + 1901 + 1201 = 2039

Step 2: Now we calculate changes in working capital i.e. Receivables + Inventories + Accounts Payable + Other assets/liabilities which comes to (-497) + (-1238) + 1723 + 70 = 58

Step 3: And finally, to calculate the Net Operating Cashflow we have to add Total funds from operations + Networking capital = 2039 + 58 = 2097

So, 2097 is the Net Operating cash flow for Tesla for that period.

• The importance of Operating activities, regardless of any business, is imperative to maximize the revenue of the company.
• Operating cash flow is an important benchmark for an analyst to determine the company's financial stability using its core business activities.
• Furthermore, format of operating activities helps to analyze the expense bearing capacity of the company, i.e., if the company can meet the expenses like labor cost or debt repayment. It is an important tool for the creditors to review the performance and for most investors looking for a prospective potential investment in the company.

• Since the company can track and examine the operating expenses from this particular head, it also helps the decision-makers to check the inflows and outflows of the company's funds, which assists them in maintaining operational efficiency and enough liquidity for the necessary needs of the business.
• Business operating activities also helps the board make important management decisions for the company. If there is enough cash available, the company can plan a new product launch or buy back certain shares, which will create a very strong financial position in the market. On the contrary, if there is a cash crunch, the company can delay some of its expansionary actions.
• In a way, positive cash flow from operations is a good sign for the business and company’s flourishment, and it acts as an additional tool other than EBITDA and Net income to determine the income potential of a company.

The activities mentioned above are two different categories of cash flows that appear in the cash flow statement of the organization, which is an important part of the financial statement apart from balance sheet and income statement. But the two activites are quite different from each other. Let us study the same.

• The former refers to the daily business activities and arise from core business operation, like the production and sale of goods. But the latter is related to purchase and sale of long term assets or projects which is not a part of the core business operation.
• The format of operating activities involves cash inflow in the form of sales revenue, dividend or interest received, etc and cash inflow for the latter is in the form of cash from sale of assets.
• The cash outflow in case of the former is wages paid to labor, salary to employees, daily cash expense for meeting operating requirements like purchase of stationery, payment of rent electricity bills, payment to suppliers, etc. But in case of the latter, the outflow is payment to attain long term assets, taking loans for growth and expansion, etc.
• The main aim of the former is to show the capacity of the business generate cash from its core activities that will help the business to run smoothly. But the main aim of the latter is to evaluate the capacity of the business for long term growth and expansion, so as to increase faith of shareholders.

Thus, the above are some important points of differences between the two types of business activities.

This has been a guide to what are Operating Activities. We explain them with examples, types, differences with investing activities & why they are important. You may learn more about financing from the following articles-

• Operating Earnings
• Formula of Operating Profit
• Non Operating Expenses
• Non Operating Income