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 statementsFinancial 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. of the company like cash flow statementCash Flow StatementStatement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities. 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..
- 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 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.; 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 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., and many more.
What is Included in Operating Activities?
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. 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., 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)
- 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 IncomeInvestment IncomeInvestment income is the earnings made from allocating funds in financial instruments or assets like securities, mutual funds, bonds, property, etc. It includes dividends on bonds and interest received on bank deposits, profits and capital gain from the sale of real estate and securities.
- Accounts ReceivablesAccounts ReceivablesAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet.
- 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 comes to -1063 + 1901 + 1201 = 2039
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. + Other assets/liabilities which comes to (-497) + (-1238) + 1723 + 70 = 58
Step 3: And finally, calculate the Net Operating Cashflow we have 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 companyMaximize The Revenue Of The CompanyRevenue maximization is the method of maximizing a company's sales by employing methods such as advertising, sales promotion, demos and test samples, campaigns, references. It aims to capture a larger market share in an industry. Technically, revenue is maximized when MR (Marginal Revenue) equals zero..
- 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 costLabor CostCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes. 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 operationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital. 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-