What is an example of an operating activity?

Does operating income equal operating cash flows? Is it good when there are negative cash flows? Answers to these and other questions are in this accounting article.

Business activities can be divided into three (3) groups:

• Operating activities
• Investing activities
• Financing activities

Operating activities are day-to-day business activities of a company which determine the company's net income (loss).

Operating activities are business activities associated with the primary purpose of a business. Examples of operating activities are listed in the table below:

Business

Operating Activities

Manufacturing

Manufacturing and selling goods

Retail

Buying and re-selling goods

Service

Selling and providing services

Operating activities involve transactions that create revenues and expenses and thus are used to determine net income (loss). In other words, operating activities are principal revenue producing activities.

The results of operating activities are reported in the operating income section of the income statement and in the operating cash flows section of the statement of cash flows. Balance sheet also reflects some of the results of operations (e.g., working capital, long-term assets, and liabilities).

For example, the statement of cash flows classifies cash receipts and payments as operating, investing, and financing activities. Typical cash receipts and payments within the operating activities category are provided below:

Operating cash receipts (inflows):

• Revenue from the sale of goods and services
• Interest income (i.e., return on loans)
• Dividends income (i.e., return on equity securities)
• Royalties, fees, commissions, and other revenue

Operating cash payments (outflows):

• Payments to employees for services
• Payments to suppliers for inventory
• Payments to lenders for interest
• Payments to government for taxes
• Payments to others for operating expenses (e.g., insurance premiums)

Important to note, some cash flows related to financing and investing activities (e.g., interest, dividend) are reported as operating activities on the statement of cash flows when these items involve income determination (i.e., are reported in the income statement).� For example, even though loan proceeds and repayment involve financing activities, interest expense is reported as an operating activity because interest expense is reported in the income statement.

Operating cash flows and a company�s net income (loss) are seldom equal due to the depreciation and amortization expense, changes in current assets and current liability accounts, etc.

It is important to evaluate operating cash flows when analyzing an entity�s going concern because a company often depends on its operating cash flows to meet its cash flow needs.

Negative operating cash flows, combined with cash inflows from investing (e.g., selling assets) and financing activities (e.g., borrowing), may indicate a serious financial problem. On the other hand, positive operating cash flows combined with negative investing cash flows indicate goods financial performance and growth. An excess in operating cash flows can be used for financial purposes (e.g., pay dividends, repurchase stock, repay debt) and growth (e.g., buy assets).

The activities involved in earning revenues. For example, the purchase or manufacturing of merchandise and the sale of the merchandise including marketing and administration. In the statement of cash flows the operating activities section identifies the cash flows involved with these activities by focusing on net income and the changes in the current assets and current liabilities.

The operating activities of a business are its core daily activities of generating revenue, marketing its product and service offerings, administering payroll and maintaining its facilities. Operating income, which is a line item on the income statement, is the difference between revenues and operating expenses, including the cost of goods sold. The operating activities section of the statement of cash flows summarizes the cash inflows and outflows from a company's core activities.

Cash-generating Activities

Revenue comes from the main cash-generating activities of a company. The two main types of revenue-generating activities are delivering products and providing services. Product delivery may include reselling merchandise supplied by other companies or manufactured in house.

For example, a small bakery may sell specialty breads supplied by a wholesaler, but it also may make its own breads and pastries. A small retailer, on the other hand, may only sell products assembled or manufactured elsewhere. Providing services may or may not include product sales. So, a barbershop provides haircuts and related services, but it also may sell hair care products to generate additional sales.

However, a management consulting business would derive its revenues solely from providing advisory services to its clients. Although interest and dividend income are part of operating cash flow, they are not a part of a company's core operating activities.

Sales-generating Activities

Companies need to promote and advertise their products and services to build awareness and generate sales. A retail store could advertise in the local papers or on other media platforms. A bakery could invite the local food critic to sample some of its offerings or even to an opening. A management consultant or a tax accountant could coordinate introductory training sessions for small businesses at the local chamber of commerce.

A home renovation company could ask its existing clients to recommend its services to neighbors and friends who might need similar services. Small business owners could use networking opportunities at trade shows, business forums, chamber of commerce luncheons, hospital fundraisers and other events to raise their profiles and grow sales.

Back Office Activities

Administrative activities include secretarial, accounting, finance and security functions. A small business may have one or two people handling all of the administrative functions because these expenses, while necessary to support a business, do not directly generate revenue; they reduce profits. A home-based business may not incur any of these costs because the owner would normally handle the administrative responsibilities. A large business, on the other hand, may have dozens of administrative personnel scattered all over the world working in human resources, contract management and other functional areas.

Everything Else that Keeps You Running

The "everything else" category includes facilities maintenance and customer service. The related expenses include rent, utilities, supplies, insurance and licenses. For example, a small restaurant would need to keep its facilities clean and its equipment in working order, while a car dealership would have to service its cars regularly and keep them in running order. Even a home-based consultancy would incur expenses related to general activities, such as producing documents and paying for courier services.

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