Operating Activities Definition
Operating activities generates the majority of the cash flows for the company as it is directly linked to the core business activities of the company like sales, distribution, production and so on, these activities also determine the profitability of the company and items categorized under this head are the primary revenue units of the company.
- Fundamental activities of a business that can directly affect the profitability of the company and are mostly the primary unit for the company are classified as the operating activities. Additionally, maintenance and administrative activities also fall under the same head.
- These activities like sales, marketing, customer service can be a part of operating activities as they help generate quarterly or annual revenue through which a company’s cost-effectiveness can be determined.
- These activities can be found under the head of Operating activities in the financial statements of the company like cash flow statement and income statement.
- There are other activities too found in these financial statements, namely Financing activities or Investing activities, and they are not directly linked with the current profitability; instead, they help the company function in the long haul.
- Cash flows reflect the inflows and outflows from the operating activities in the company’s financial statement, and after the expenses are deducted from the income, we get Operating Income.
- Cash flows from operating activities may act as a financial parameter for analysts and investors to determine the functionality of the company.
- Operating cash flow can determine the capacity of the company to repay the current expenses like labor wages, administrative expenses, and many more.
What is Included in Operating Activities?
#1 – Operating Expenses (Cash outflow)
- Employee Salary Payments
- Interest expense to the creditors
- Interest on Loan and Dividends
- Lawsuit fine or fees for legal settlements
- Advertising Expenses
#2 – Operating Income (Cash Inflow)
- Cash Sales
- Investment Income
- Accounts Receivables
- Refunds from Suppliers
- Settlement of Insurance or legal lawsuit claims
These are only some examples of the operating costs and revenue listed above, where after deducting the operating expense from the operating income, we can get to the Net Operating Revenue.
Example of Operating Activities
Let us see an example to understand the concept in an illustrative manner; below is the data available from the financial statements of Tesla. Let us see what kind of operating activities a company like Tesla reports.
Step 1: Let us calculate Total funds from operation i.e. Net Income + Depreciation, Depletion & amortization + Other funds which come to -1063 + 1901 + 1201 = 2039.
Step 2: Now we calculate changes in working capital by adding Receivables + Inventories + Accounts Payable + Other assets/liabilities i.e. (-497) + (-1238) + 1723 + 70 = 58
Step 3: And finally, to calculate the Net Operating Cashflow we have to add Total funds from operations + Networking capital = 2039 + 58 = 2097
- So, 2097 is the Net Operating cash flow for Tesla for that period.
Why are Operating Activities Important?
- The importance of Operating activities, regardless of any business, is imperative to maximize the revenue of the company.
- Operating cash flow is an important benchmark for an analyst to determine the financial stability of the company using its core business activities.
- Furthermore, it helps to analyze the expense bearing capacity of the company, i.e., if the company can meet the expenses like labor cost or debt repayment. It is an important tool for the creditors to review the performance and for most investors looking for a prospective potential investment in the company.
- Since the company is able to track and review the operating expenses from this particular head, it also helps the decision-makers to check the inflows and outflows of the company’s funds, which assists them in maintaining operational efficiency and enough liquidity for necessary needs of the business.
- It also helps the board to make important management decisions for the company, like if there is enough cash available, the company can plan a new product launch or buy back certain shares, which will create a very strong financial position in the market. On the contrary, if there is a cash crunch, the company can delay some of its expansionary actions.
- In a way, positive cash flow from operations is a good sign for the business and company’s flourishment, and it acts as an additional tool other than EBITDA and Net income to determine the income potential of a company.
Operating activities are the core activities of any company like Sales, administration, marketing and some other depending on the company’s operations, this activity and the operating income assists us to analyze any company from the investment or functional perspective.
This has been a guide to Operating Activities and its definition. Here we discuss why operating activities are important along with its list and an example. You may learn more about financing from the following articles-