Cash Flows from Operating, Investing, and Financing Activities

The cash flow statement gives information on a company’s cash receipts and payments during a specified period of time. This information can help users of financial statements (creditors, investors, analysts, etc.) evaluate a company’s liquidity and solvency.

Components of the Cash Flow Statement

There are three components of the Cash Flow Statement:

• Cash Flow from Operating Activities: this provides information on cash flows that are derived from the day-to-day activities of a company. Among others, these cash flows include proceeds from the sale of inventory, and from the provision of services or other activities that are not related to financing or investing. Further, cash flows from operating activities also include cash receipts and payments arising from dealing or trading in securities (not for investment purposes);

• Cash Flow from Investing Activities: this provides information on cash flows that are derived from the purchase and sale of long-term assets and other investments. Such ventures include the purchase or sale of property, plant, and equipment, intangible assets, and investments in the debt and equity issued by other companies; and

• Cash Flow from Financing Activities: this provides information on cash flows that are derived from acquiring or repaying capital. Cash inflows would arise from the issuance of stock or bonds and borrowing, while cash outflows would include cash payments for repurchasing stock and repaying bonds or other borrowings.

Question 1

Which of the following would be classified as a cash flow from investing activity?

1. Proceeds from the issuance of bonds.
2. Proceeds from the sale of machinery.
3. Cash received from the sale of inventory.

Solution

The correct answer is B.

Proceeds from the sale of machinery is an example of cash derived from an investing activity.

 A is incorrect because proceeds from the issuance of bonds relate to a financing activity.

C is incorrect because the sale of inventory is an operating activity.

Question 2

How would you classify the cash flow related to paying for shipping expenses of product materials and a new production machine, respectively?

1. Both are operating cash flows.
2. Investing cash flow; and operating cash flow.
3. Operating cash flow; and investing cash flow.

Solution

The correct answer is C.

The first cash outflow is an operating activity. This is because it is related to the production activities of the company. The second cash outflow is an investing activity since it is related to the acquisition of a long-term asset.