Generating cash from operating activities allows businesses to fulfill their mission and financial goals. Owners must recognize how operating activities affect cash to understand their business fully.
A cash flow statement records changes in a business's cash over a given period. The statement divides cash flows into three sections: operating activities, investing activities, and financing activities.
The cash flow from operating activities section shows how a business received and paid cash to conduct its core functions. Some cash flow statements call this section net cash provided by operating activities.
Operating activities explained
Operating activities are directly related to a business's primary purpose. They allow the company to provide its products and services. Operating activities relate to transactions that affect net income.
Operating activities examples include:
- Receipt of cash from sales.
- Collection of accounts receivable.
- Receipt or payment of interest.
- Payment for materials and supplies.
- Payment of salaries.
- Payment of principal and interest for operating leases. Principal payments for leases considered as purchases, known as capital leases, are financing activities.
- Payment of taxes, fines, and license costs.
- Any item not specifically defined as an investing activity or financing activity.
Cash flow from operating activities includes only transactions involving cash.
What cash flow from operating activities means for your business
Businesses need to generate significant cash flow from operating activities over the long term to survive.
The core functions of the business—plus debt and equity—must provide the cash to purchase long-term productive assets. In other words, operating activities and financing activities fund investment.
Attracting lenders and investors requires the current or future ability to generate cash flow from operating activities. Maximizing cash flow from operating activities is critical at every point in a business's life cycle.
Young, cash-hungry businesses often focus on minimizing negative cash flow from operating activity. This practice both conserves precious cash and makes the company more attractive to lenders and investors.
Consistently negative cash flow from operating activities indicates a severe problem for mature businesses. Possible causes include unprofitability and growing working capital—current assets minus current liabilities.
Businesses require working capital to meet short-term resource needs. However, excessive non-cash working capital may reveal problems. Examples include poor collection practices for increasing accounts receivable and lower than expected demand for increasing inventory.
How to calculate cash flow from operating activities
Businesses may use either the direct method or indirect method to calculate cash flow from operating activities.
Few businesses use the direct method because it requires listing all cash received or paid for operating activities. Accrual accounting systems do not automatically produce all the required information.
By contrast, the indirect method starts with net income and makes adjustments to arrive at cash flow from operating activities. Adjustments include non-cash expenses and changes to any account affecting working capital.
Under the indirect method, cash flow from operating activities is a formula that equals net income, plus non-cash expenses, minus the net change in working capital.
The example cash flow statement below, prepared using the indirect method, shows only the cash flow from operating activities section.
Company ABC cash flow from operating activities
Additions to cash
- Depreciation $45,000
- Decrease in inventory $17,000
- Increase in accounts payable $39,000
- Increase in taxes payable $3,000
Subtractions from cash
- Increase in accounts receivable ($84,000)
- Decrease in accrued liabilities ($22,000)
Net cash provided by operating activities $698,000
Company ABC earned $700,000 in net income. Add $45,000 of non-cash expenses, in this case, from depreciation. Then subtract the $47,000 net change in working capital—the net total of all other items in the example. The result is a cash flow from operating activities of $698,000.
Every business must generate cash flow from operating activities sooner or later. Business owners become better at managing their business when they can track operating activities, learn how to calculate cash flow from operating activities, and understand why that metric matters.
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FAQs
Operating activities: Operating activities are those cash flow activities that either generate revenue or record the money spent on producing a product or service. Operational business activities include inventory transactions, interest payments, tax payments, wages to employees, and payments for rent.
How do you solve for operating activities? ›
Operating activities include generating revenue, paying expenses, and funding working capital. It is calculated by taking a company's (1) net income, (2) adjusting for non-cash items, and (3) accounting for changes in working capital.
What are three operating activities? ›
Operating activities examples include:
- Receipt of cash from sales.
- Collection of accounts receivable.
- Receipt or payment of interest.
- Payment for materials and supplies.
- Payment of salaries.
- Payment of principal and interest for operating leases. ...
- Payment of taxes, fines, and license costs.
What are Normal Operating Activities? Normal operating activities are the ongoing activities engaged in by a business to pursue its mission. For example, the purchase of goods and their conversion into machinery would represent normal operating activities for a manufacturer.
What are operating activities classified? ›
Operating activities. include cash activities related to net income. For example, cash generated from the sale of goods (revenue) and cash paid for merchandise (expense) are operating activities because revenues and expenses are included in net income.
What are 5 examples of business activity? ›
Here are some examples or scenarios for the following six basic business activities:
- Operations and Logistics. ...
- Sales and Marketing. ...
- General Administration. ...
- Customer Service. ...
- Budgeting and Forecasting. ...
- Accounting and Auditing.
There are two methods for depicting cash from operating activities on a cash flow statement: the indirect method and the direct method.
What statement shows operating activities? ›
You can find the cash flow from operating activities on a company's cash flow statement. This section normally appears at the top of the statement. You can also calculate operating cash flow by adding together a company's net income, non-cash items (adjustments to net income), and working capital.
Why are operating activities important? ›
Operating activities are the core activities that a business performs to earn revenue. These activities affect the cash flow coming in and out and determine the net income of the business. Some fundamental operating activities for a business are sales, customer service, administration and marketing.
What are the two formats of operating activities? ›
There are two methods for reporting cash flow from operating activities, the direct method and the indirect method.
Explanation: Cash transactions such as the payment of rent or the sale of inventory that are incurred as part of daily operations are included within operating activities.
Which of the following is not an operating activity? ›
Expert-Verified Answer
The answer is "Cash receipts for interest earned." Operating activities are activities related to the core operations of a business such as cash collections from credit customers, cash payments for operating expenses, and cash payments for dividends to stockholders.
How do you explain operating activities? ›
Operating activities are all the things a company does to bring its products and services to market on an ongoing basis. Non-operating activities are one-time events that may affect revenues, expenses or cash flow but fall outside of the company's routine, core business. Operating activities include: Setting a strategy.
How to calculate operating activities? ›
Operating cash flow (OCF) is how much cash a company generated (or consumed) from its operating activities during a period. The OCF calculation will always include the following three components: 1) net income, 2) plus non-cash expenses, and 3) minus the net increase in net working capital.
What is operating activities mainly concerned with? ›
Operating Activities
These are the main or primary activities of a business. Operating activities mainly deals with major activities of buying and selling of goods and services of a business firm. These activities include manufacturing, distributing, selling, marketing etc.
Which is an example of an operational business activity? ›
Functions such as accounting, purchasing, human resources, purchasing, facility maintenance and information technology are included under operational activities.
What are operating tasks? ›
Operational tasks are the ones that keep your team running smoothly and efficiently, such as managing budgets, schedules, resources, and performance. Strategic tasks are the ones that help you align your team's goals with the organization's vision, such as planning, innovating, problem-solving, and communicating.
What are the operating activities on a balance sheet? ›
Operating activities heavily influence the value of current assets listed on your balance sheet. Current assets include cash and anything you expect to turn into cash within a year. The revenue you earn from sales appears on the balance sheet as cash or, for sales made on credit, as accounts receivable.
What does operating activities mean cash flow? ›
Cash flow from operating activities (CFO) indicates the amount of money a company brings in from its ongoing, regular business activities, such as manufacturing and selling goods or providing a service to customers. It is the first section depicted on a company's cash flow statement.
