Cash Flows from Operating Activities
International Accounting Standard 7 (IAS 7) defines operating activities as “the principal revenue-producing activities of the entity and other activities that are not investing or financing activities”.
Cash flows mean the inflows and the outflows of cash and cash equivalents. By cash we mean cash on hand and demand deposits. While the cash equivalents comprise short-term liquid investments that are quickly convertible to cash and which are subject to very little risk of changes in value.
The inflows and outflows of cash and cash equivalents for the operating activities are termed as “cash flows for operating activities”. The cash flows from operating activities are most commonly derived from the primary revenue-generating activities of a business or an entity. This is the amount of cash generated by an entity from its core business as opposed the peripheral activities such as financing or investing.
Following are some of the common examples of cash flows from operating activities.
Examples of Inflows:
- Cash collected from customers against sale of goods or rendering of services
- Cash collections from “other revenues” such as commissions, royalties, and fees
- Cash refunded against income taxes if they cannot be specifically identified with the investing or financing activities
Examples of Outflows:
- Cash paid to vendors against supply of goods or services
- Cash paid to or on behalf of employees of the entity
- Cash paid against income taxes if they cannot be specifically identified with the investing or financing activities
In addition to the above examples, cash flows from trading or dealing in futures and options and, in case of insurance companies, cash receipts and payments for premiums and claims are also examples of cash flows from operating activities.
Apart from these, the cash flows that cannot be classified as cash flows from investing or financing activities are also classified as cash flows from operating activities.
Cash flows from operating activities are a critical indicator of the financial strength of an entity because they are the most important source of internal finance. They represent an organization’s ability to maintain its operating activities, service debts, repay loans, pay dividend, and make capital investments without recourse to external funding.