Cash Flows from Operating, Investing, and Financing Activities

Introduction

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, such as from the sale of inventory, and from providing services or other activities that are not of a financing or investing nature. It also includes cash receipts and payments arising from the 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, inclusive 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 from 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?

A. Proceeds from the issuance of bonds

B. Proceeds from the sale of machinery

C. 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. Choice A is incorrect because proceeds from the issuance of bonds relate to a financing activity. Also, choice 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:

I. Product materials

II. A new production machine

A. The cash flow related to paying for shipping expenses of product materials should be classified under investing cash flow; and the cash flow related to paying for shipping expenses of a new production machine should be classified under operating cash flow.

B. Both are operating cash flows.

C. The cash flow related to paying for shipping expenses of product materials should be classified under operating cash flow, and the cash flow related to paying for shipping expenses of a new production machine should be classified under investing cash flow.

Solution

The correct answer is C.

The first cash outflow is an operating activity, as it’s related to the production activities of the company. The second cash outflow is an investing activity, as it’s related to the acquisition of a long-term asset.

Reading 25 LOS 25a:

Compare cash flows from operating, investing, and financing activities and classify cash flow items as relating to one of those three categories given a description of the items


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