Question

Why might an investor say that the statement of cash flow is the most important financial statement? What are the 3 main activities found on the statement of cash flows? How would you describe these in your own words? Give examples of items found in each section.

Answer 1

Cash flow statement Activities

1.Operating Activities

2.Investing Activities

3.Financing Activities

Operating Activities:

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. Even though these activities does not include investing and financing activities but provides a major cash flow in the organization and also helps in better assessing the profitability of the firm.

Cash Flow From Operating Activities = Earnings before interest and Tax + depreciation – Taxes +/- Change in working capital

Example

Cash Inflows from Operating Activities

Receipts from the sale of goods and services.

Cash receipts from the sale of patents.

Cash Outflows from Operating Activities

Payments made on salaries to the employees.

Cash payments made to suppliers.

Investment Activities

Investment activities are the other type of cash flow statement activities in which cash transactions made on purchasing or sale of investments. These activities include money spent on long-term assets, shares, debentures etc.

These activities provide minor cash flow in the firm when compared with operating activities but have a great impact on the profitability of the firm. Cash flow from investment activities helps in the growth of capital also creates stability of the firm.

Cash Inflow from Investment Activities

Investment activities cash inflow include the sale of assets.

Cash received on interest on loans and advances given to the third parties.

Cash receipts received on the investment made in the other companies or firms.

Receipts received on trading of shares, debentures, bonds etc.

Cash Outflow from Investment Activities

Cash payments on purchasing long-term assets and other intangible goods like patents.

Payments made on acquiring of other company shares, debentures and other debt issues.

Advances and loans given to third parties.

Financing Activities:

Financing activities can be defined activities involving in the rise of the company’s capital. Even though these lie at the bottom of the statement but had its own importance. These activities are confined mainly financial activities of the firm like trading of company’s shares, repaying investors, adding or changing loans, or issuing more stock whenever required. Most importantly these activities change the capital and borrowings of the firm.

Cash Flow from Financing activity = Cash Received from Issuing shares or debts – Cash Paid as Dividends and Reacquiring of shares or debts

Cash Inflow from Financing Activities

Receipts on the issuing of shares and other debt instruments.

Cash received from issuing of debentures, loans and other borrowings.

Cash Outflow from Financing Activities

Interest paid on long-term borrowings and debentures.

Dividends paid to the shareholders of the company.

Repaid borrowings made by the firm.