Cash Flows from Operating Activities
Cash flows from operating activities are a category within the statement of cash flows that reflects the cash inflows and outflows generated by a company’s core business operations. Operating activities involve the production, sales, and delivery of goods and services, as well as other activities that are part of a company’s day-to-day operations. Cash flows from operating activities provide insights into the cash-generating efficiency and financial health of a company’s primary business activities.
Examples of cash flows from operating activities include:
- Cash received from customers: This includes the cash inflows generated by sales of goods and services.
- Cash paid to suppliers and employees: This includes the cash outflows related to the cost of goods sold (COGS), salaries, wages, and other operating expenses.
- Cash received from interest and dividends: This includes the cash inflows from interest earned on investments and dividends received from investments in other companies.
- Cash paid for interest and taxes: This includes the cash outflows for interest payments on loans or bonds and payments for income taxes.
To calculate the net cash flow from operating activities, there are two methods: the direct method and the indirect method.
- Direct method: This method requires listing all cash inflows and outflows related to operating activities and calculating the net cash flow by subtracting cash outflows from cash inflows.
- Indirect method: This method starts with the net income (from the income statement) and adjusts it for non-cash items, such as depreciation and changes in working capital (current assets and current liabilities).
Cash flows from operating activities are an important indicator of a company’s financial performance and ability to generate positive cash flow to fund its growth, pay off debts, or return value to shareholders through dividends or share buybacks.
Example of Cash Flows from Operating Activities
Let’s consider a hypothetical example of cash flows from operating activities for a company called TechSmart Inc. We’ll use the indirect method for this example.
TechSmart Inc. Income Statement for the financial year:
- Net Income: $150,000
- Depreciation Expense: $25,000
- Increase in Accounts Receivable: -$10,000 (cash outflow)
- Decrease in Inventory: $5,000 (cash inflow)
- Increase in Accounts Payable: $20,000 (cash inflow)
- Decrease in Prepaid Expenses: $3,000 (cash inflow)
- Increase in Accrued Liabilities: $7,000 (cash inflow)
To calculate the net cash flow from operating activities, we need to adjust the net income for non-cash items and changes in working capital:
Net cash flow from operating activities = Net Income + Depreciation Expense + (- Increase in Accounts Receivable) + Decrease in Inventory + Increase in Accounts Payable + Decrease in Prepaid Expenses + Increase in Accrued Liabilities
Net cash flow from operating activities = $150,000 + $25,000 – $10,000 + $5,000 + $20,000 + $3,000 + $7,000
= $200,000
In this example, TechSmart Inc. had a net cash inflow of $200,000 from operating activities during the financial year. This indicates that the company’s core business operations generated positive cash flow, which can be used to fund its growth, pay off debts, or return value to shareholders.
Keep in mind that this is just one part of the overall cash flow statement. To get a complete picture of a company’s cash management, you also need to consider cash flows from investing activities and cash flows from financing activities.
