Operating Activities

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Are Operating Activities?

Operating activities generate 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.

Operating Activities

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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 assist us in analyzing any company from the investment or functional perspective.

Operating Activities Explained

Fundamental activities of a business that can directly affect the company’s profitability and are mostly the primary unit of the company are classified as the operating activities. Additionally, maintenance and administrative activities also fall under the same head operating activities in accounting.

These activities can be found under the head of Operating activities in the financial statementsCompany's Financial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more like cash flow statementCash Flow StatementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more and income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more.

Other activities are found in these financial statements, namely Financing activities or Investing activities. They are not directly linked with the current profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more;  instead, they help the company function in the long haul.

Cash flows reflect the operating activities in cash flow statement which include 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 IncomeOperating IncomeOperating Income, also known as EBIT or Recurring Profit, is an important yardstick of profit measurement and reflects the operating performance of the business. It doesn’t take into consideration non-operating gains or losses suffered by businesses, the impact of financial leverage, and tax factors. It is calculated as the difference between Gross Profit and Operating Expenses of the business.read more.

Cash flows from operating activities may act as a financial parameter for analysts and investors to determine the company’s functionality.

Operating cash flow can determine the capacity of the company to repay the current expenses like labor wages, administrative expensesAdministrative ExpensesAdministrative expenses are indirect costs incurred by a business that are not directly related to the manufacturing, production, or sale of goods or services provided, but are necessary for the smooth functioning of business operations, such as information technology, finance & accounts.read more, and many more.

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Types

The activities like sales, marketing, and customer service can be a part of operating activities. They help generate quarterly or annual revenue through which a company’s cost-effectiveness can be determined. Let us try to understand the different types of the same.

It includes two sections Operating RevenueOperating RevenueOperating revenue is defined as revenue earned by an individual, corporation, or organization from the core activities that they undertake on a regular basis. There are several methods to earn revenue, but operational revenue is earned by the core business activities that the organization undertakes in its daily operations.read more and Operating ExpensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more, through which we will get to operating income. Let us understand these two heads with the activities categorized under each of them;

#1 – Operating Expenses (Cash outflow) – The operating activities in cash flow statement can also be in the form of cash outflow like payments made to various parties like employees, suppliers, vendors, etc. Cah outfow can also be due to interest payment on loans, dividend payments to shareholders, etc. Payments can also be in the form of income tax or daily operating expenses incurred for running the business. They are listed below:

#2 – Operating Income (Cash Inflow) – The cash inflow can be in various forms. In can be in the form of revenue that is earned from sale of goods and services, the interest or dividend income from lending and investments in other organizations, any kind of intangible assets like patents, copyrights, intellectual property, etc. Cash inflow can come from other sources also like commissions and fees that are earned from advisory and financial services and also from real estates. Thus, they can be listed below.

#3- Research and Expansion – The business often need to use fund for the expansion and growth of the business. This operating activities in accounting can be in the cash spent on buying better and innovative products, hiring more labor for handling more jobs, or payment to contractors.

#4- Other operating activites– This will include any amount of cash generated due to profit or loss from disposing off long term assets. Sometimes the business also needs to put some cash aside for meeting unexpected expenses or bad debts that cannot be collected any more.

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.

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Example

Let us see an example to understand the concept of business operating activities in an illustrative manner; below is the data available from its financial statements of Tesla. First, let us see what kind of operating activities a company like Tesla reports.

Solution

Step 1: Let us calculate Total funds from operation i.e Net Income + Depreciation, Depletion & amortization + Other funds which comes to -1063 + 1901 + 1201 = 2039

Operating Activities Example

Step 2: Now we calculate changes in working capital i.e. Receivables + Inventories + Accounts PayableAccounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more + Other assets/liabilities which comes to (-497) + (-1238) + 1723 + 70 = 58

Operating Activities Example 1

Step 3: And finally, to calculate the Net Operating Cashflow we have to add Total funds from operationsFunds From OperationsFFO (Funds from Operations) is a term used to describe the cash flows generated by Real Estate Investment Trusts (REITs). It is calculated by deducting interest income and gains on asset sales from net income for the period and adding interest expense, depreciation, and losses on asset sales.read more + Networking capital = 2039 + 58 = 2097

Operating Activities Example 2

So, 2097 is the Net Operating cash flow for Tesla for that period.

Why Are Operating Activities Important?

Operating Activities Vs Investing Activities

The activities mentioned above are two different categories of cash flows that appear in the cash flow statement of the organization, which is an important part of the financial statement apart from balance sheet and income statement. But the two activites are quite different from each other. Let us study the same.

  • The former refers to the daily business activities and arise from core business operation, like the production and sale of goods. But the latter is related to purchase and sale of long term assets or projects which is not a part of the core business operation.
  • The format of operating activities involves cash inflow in the form of sales revenue, dividend or interest received, etc and cash inflow for the latter is in the form of cash from sale of assets.
  • The cash outflow in case of the former is wages paid to labor, salary to employees, daily cash expense for meeting operating requirements like purchase of stationery, payment of rent electricity bills, payment to suppliers, etc. But in case of the latter, the outflow is payment to attain long term assets, taking loans for growth and expansion, etc.
  • The main aim of the former is to show the capacity of the business generate cash from its core activities that will help the business to run smoothly. But the main aim of the latter is to evaluate the capacity of the business for long term growth and expansion, so as to increase faith of shareholders.

Thus, the above are some important points of differences between the two types of business activities.

Recommended Articles

This has been a guide to what are Operating Activities. We explain them with examples, types, differences with investing activities & why they are important. You may learn more about financing from the following articles-

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