Operating activities are the core business activities that a company undertakes on a regular basis to generate revenue and subsequently earn profit. These activities are reflected in the company’s income statement and are usually related to the production, sales, and delivery of a company’s products and services.
Operating activities can include:
- Cash receipts from the sale of goods or services.
- Cash payments to suppliers for inventory.
- Cash payments to employees for wages and salaries.
- Interest payments on loans.
- Payments for utilities, rent, insurance, and other operating expenses.
Operating activities are distinct from investing activities, which are related to the acquisition and disposal of long-term assets, and financing activities, which are related to obtaining or repaying capital and funding.
In the statement of cash flows, a key financial statement, cash flows from operating activities indicate how much cash a company generates from its core business operations. This is an important metric for investors and creditors, as it shows the company’s ability to generate sufficient cash to maintain and grow its operations. If a company consistently generates more cash from operating activities than it uses, it has strong operational efficiency and financial health. Conversely, a company that consistently spends more cash in operating activities than it generates may face liquidity issues in the long run.
Example of Operating Activities
Let’s take a look at a fictional tech company, TechRise Inc., to understand how operating activities work:
TechRise Inc. generates its revenue primarily from the sales of its software products and related services. Here are some examples of its operating activities:
- Cash Receipts from Sales of Goods and Services: TechRise receives money from customers who buy its software or pay for ongoing service and maintenance contracts. These receipts are the primary source of cash inflow from operating activities.
- Cash Payments to Suppliers for Inventory: TechRise may pay suppliers for goods and services needed in its operations, like buying hardware for developing and testing its software, or paying for cloud services.
- Cash Payments to Employees for Wages and Salaries: As part of its operations, TechRise pays its employees for their work. This includes software developers, customer service representatives, salespeople, and management.
- Payments for Utilities, Rent, and Other Operating Expenses: TechRise pays for the electricity used in its offices, the rent for its office spaces, and perhaps marketing and advertising costs for promoting its products and services.
- Interest Payments on Loans: If TechRise has taken out any loans for its operations, interest payments on these loans would also be considered an operating activity.
These operating activities are part of the company’s regular, day-to-day operations. They are necessary for TechRise to produce, sell, and deliver its software products and services to customers, which in turn generates its primary source of revenue.
If you were to look at TechRise’s statement of cash flows, you would see a section dedicated to cash flows from operating activities. This section would summarize the cash inflows and outflows related to these activities for the accounting period, and provide a clear picture of how much cash the company’s main business operations are generating.