How Business Activities are Classified

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When reporting on a company’s financial position and performance, it is very important to appropriately classify various business activities of the company. Understanding how this classification is done lays the foundation for understanding financial reporting mechanics. Indeed, this helps in the identification of the areas in which a company is doing well.

Classifying Business Activities

For financial reporting purposes, a company’s business activities can be classified into three groups: operating, investing, and financing activities.

1. Operating activities are activities which form part of a company’s daily business operations. These, for example, include the sale of merchandise for a sales company, and deposit taking by a bank.
2. Investing activities are activities that are associated with the acquisition and disposal of long-term assets. They, for example, include the purchase of new equipment or a new building.
3. Financing activities are activities related to obtaining or repaying capital mainly from shareholders and creditors. These include issuing common shares, bonds or taking out a bank loan.

Of the three types of activities, analysts prefer to have most of a company’s profits and cash flow derived from its operating activities.

Question

Which of the following activities would be considered an investing activity?

A. The sale of surplus equipment

B. The issuance of bonds

C. The sale of products

Solution

The correct answer is A.

The sale of surplus equipment would be considered an investing activity. On the other hand, the issuance of bonds and sale of products would be considered financing and operating activities respectively.

Reading 22 LOS 22a:

Describe how business activities are classified for financial reporting purposes