Understanding Cash Flow: Operating, Investing, and Financing
Cash flows from operating activities are primarily caused by activities that constitute the main source of company revenue, as well as other activities that cannot be classified as investment or financing activities. Operating cash flow is key because it demonstrates, from a financial standpoint, the company’s potential to meet its liquid fund needs through its core business operations.
Investing Activities
From a financial perspective, another group of activities is called investing activities. This also includes divestiture activities. Investing activities are those associated with the acquisition of non-current assets and other assets not included in cash and/or cash equivalents. Conversely, divestiture activities are those derived from the sale of non-current assets and other assets not included in cash or cash equivalents.
It consists of:
- Payments for investments (-)
- Collections from divestitures (+)
- Cash flows from investing activities (Payments – Collections)
The net balance of these investment/divestment activities indicates the impact that investment/divesting efforts have had on the company’s treasury during the period. A positive balance overall indicates more divestitures, while a negative balance indicates more investments.
Financing Activities
A positive net balance of these activities indicates that the company has increased its funding (either its own or from external sources) during the period. A negative net balance indicates that the company has decreased its funding (either its own or from external sources) during the reporting period.
It consists of:
- Collections and payments related to financial instruments and equity.
- Collections from passive financial instruments.
- Payments for dividends and earnings of other equity instruments.
- Cash flows from financing activities (Collections +/- Payments)
Preparation of Cash Flow Statements: Indirect Method for Operating Activities
The management of operating activities generates (or consumes) a specified amount of cash. Using the indirect method, cash flow from operating activities is determined by:
- Profit for the year before taxes
- +/- Adjustments of the result
- +/- Changes in current capital
- +/- Other cash flows from operating activities
- Cash flows from operating activities
Adjustments to Result
Adjustments to the result involve eliminating the following from the company’s total result:
- Charges to income that do not involve payments (e.g., depreciation, impairments).
- Income that does not involve charges (e.g., transfer of capital grants to the result, work performed for immobilized assets).
- Adjustments for results from the sale of physical or financial assets, which are not operating activities. The amount of profit or loss from these operations must be removed to find flows from operating results.
- The amount charged for the price of a sale is contained in the cash flow statement as a cash inflow in the investment activity section.
- The price paid for a purchase is contained in the cash flow statement as a cash outflow in the investment activity section.
- Income differences in charges and fair value changes.