What are cash operating activities?

Inhaltsverzeichnis Show

Cash Flow from Operating Activities Formula
Non-Cash Expenses
Changes in Net Working Capital (NWC)
Net Working Capital (NWC) Assets
Net Working Capital (NWC) Liabilities
Cash Flow from Operating Activities Limitations
Learning Objective
Key Takeaway

Cash Flow Statement Core Concepts

Cash Flow from Operating Activities (CFO)

Cash Flow from Investing Activities (CFI)

Cash Flow from Financing Activities (CFF)

In This Article

What is the definition of cash flow from operating activities?
What is the starting line item on the cash flow from operating activities section?
How do changes in net working capital (NWC) impact cash flow?
What are the main drawbacks to the cash flow from operations metric?

Cash Flow from Operating Activities Formula

The “Cash Flow from Operations” is the first section of the cash flow statement, with net income from the income statement flowing in as the first line item.

Starting from net income, non-cash expenses like depreciation and amortization (D&A) are added back and then changes in net working capital (NWC) are accounted for.

Cash Flow from Operations = Net Income + Non-Cash Expenses +/– Changes in Working Capital

Non-Cash Expenses

Non-cash add-backs increase cash flow as they are not actual outflows of cash, but rather accounting conventions.

For instance, depreciation is the allocation of capital expenditures (CapEx) across the purchased asset’s useful life assumption, which is done to abide by the matching principle (i.e. expenses are matched with corresponding benefits).

Typically, D&A is embedded within COGS/OpEx on the income statement, which reduces taxable income and thus net income.

Since net income represents the profits under accrual accounting, the CFS adjusts the net income value to assess the true cash impact — starting by adding back non-cash charges.

Changes in Net Working Capital (NWC)

Under accrual accounting, revenue is recognized when the product/service is delivered (i.e. “earned”), as opposed to when cash is received.

In effect, this leads to the creation of line items such as accounts receivable which is counted as revenue recognized on the income statement, but whose cash payment has not actually been received yet.

Working Capital Assets	Working Capital Liabilities
Accounts Receivable (A/R)


	Other Current Liabilities

Moreover, the cash impact for changes in working capital are as follows:

Net Working Capital (NWC) Assets

Increase in NWC Asset → Decrease in Cash
Decrease in NWC Asset → Increase in Cash

Net Working Capital (NWC) Liabilities

Increase in NWC Liability → Increase in Cash
Decrease in NWC Liability → Decrease in Cash

If accounts receivable (A/R) were to increase, purchases made on credit have increased and the amount owed to the company sits on the balance sheet as A/R until the customer pays in cash.

Once the customer fulfills their end of the agreement (i.e. cash payment), A/R declines and the cash impact is positive.

Another current asset would be inventory, where an increase in inventory represents a cash reduction (i.e. a purchase of inventory).

On the other hand, if accounts payable (A/P) were to increase, the company owes more payments to suppliers/vendors but has not yet sent the cash (i.e. the cash is still in the company’s possession in the meantime).

Once the company pays the suppliers/vendors for the products or services already received, A/P declines and the cash impact is negative as the payment is an outflow.

With that said, an increase in NWC is an outflow of cash (i.e. ”use”), whereas a decrease in NWC is an inflow of cash (i.e. “source”).

Cash Flow from Operating Activities Limitations

Net income would be equivalent to CFO if net income were just comprised of cash revenue and cash expenses.

Cash flow from operations adjusts net income, which is an accounting measure susceptible to discretionary management decisions.

The major drawback is that capital expenditures (CapEx) — typically the most significant cash outflow for companies — are not accounted for in CFO.

Therefore, cash flow from operations is more objective and less prone to accounting manipulation in comparison to net income, yet is still a flawed measure of free cash flow (FCF) and profitability.

Learning Objective

Describe the three categories of cash flows.

Question: What are the three types of cash flows presented on the statement of cash flows?

Answer: Cash flows are classified as operating, investing, or financing activities on the statement of cash flows, depending on the nature of the transaction. Each of these three classifications is defined as follows.

Operating activitiesA section of the statement of cash flows that includes cash activities related to net income, such as cash receipts from sales revenue and cash payments for merchandise. include cash activities related to net income. For example, cash generated from the sale of goods (revenue) and cash paid for merchandise (expense) are operating activities because revenues and expenses are included in net income.
Investing activitiesA section of the statement of cash flows that includes cash activities related to noncurrent assets, such as cash receipts from the sale of equipment and cash payments for the purchase of long-term investments. include cash activities related to noncurrent assets. Noncurrent assets include (1) long-term investments; (2) property, plant, and equipment; and (3) the principal amount of loans made to other entities. For example, cash generated from the sale of land and cash paid for an investment in another company are included in this category. (Note that interest received from loans is included in operating activities.)
Financing activitiesA section of the statement of cash flows that includes cash activities related to noncurrent liabilities and owners’ equity, such as cash receipts from the issuance of bonds and cash payments for the repurchase of common stock. include cash activities related to noncurrent liabilities and owners’ equity. Noncurrent liabilities and owners’ equity items include (1) the principal amount of long-term debt, (2) stock sales and repurchases, and (3) dividend payments. (Note that interest paid on long-term debt is included in operating activities.)

Figure 12.1 "Examples of Cash Flows from Operating, Investing, and Financing Activities" shows examples of cash flow activities that generate cash or require cash outflows within a period. Figure 12.2 "Examples of Cash Flow Activity by Category" presents a more comprehensive list of examples of items typically included in operating, investing, and financing sections of the statement of cash flows.

Figure 12.2 Examples of Cash Flow Activity by Category

*Receipts of cash for dividends from investments and for interest on loans made to other entities are included in operating activities since both items relate to net income. Likewise, payments of cash for interest on loans with a bank or on bonds issued are also included in operating activities because these items also relate to net income.

Question: Which section of the statement of cash flows is regarded by most financial experts to be most important?

Answer: The operating activities section of the statement of cash flows is generally regarded as the most important section since it provides cash flow information related to the daily operations of the business. This section answers the question, “how much cash did we generate from the daily activities of our core business?” Owners, creditors, and managers are most interested in cash flow generated from daily activities rather than from a one-time issuance of stock or a one-time sale of land. The operating activities section allows stakeholders to assess the ongoing viability of the company. We discuss how to use cash flow information to evaluate organizations later in the chapter.

Cash Activity at Home Depot and Lowe’s

The Home Depot. Inc., and Lowe’s Companies, Inc., are large home improvement retail companies with stores throughout North America. A review of the statements of cash flows for both companies reveals the following cash activity. Positive amounts are cash inflows, and negative amounts are cash outflows.

This information shows both companies generated significant amounts of cash from daily operating activities; $4,600,000,000 for The Home Depot and $3,900,000,000 for Lowe’s. It is interesting to note both companies spent significant amounts of cash to acquire property and equipment and long-term investments as reflected in the negative investing activities amounts. For both companies, a significant amount of cash outflows from financing activities were for the repurchase of common stock. Apparently, both companies chose to return cash to owners by repurchasing stock.

Key Takeaway

The three categories of cash flows are operating activities, investing activities, and financing activities. Operating activities include cash activities related to net income. Investing activities include cash activities related to noncurrent assets. Financing activities include cash activities related to noncurrent liabilities and owners’ equity.

Identify whether each of the following items would appear in the operating, investing, or financing activities section of the statement of cash flows. Explain your answer for each item.

Cash payments for purchases of merchandise
Cash receipts from sale of common stock
Cash payments for equipment
Cash receipts from sales of goods
Cash dividends paid to shareholders
Cash payments to employees
Cash payments to lenders for interest on loans
Cash receipts from collection of principal for loans made to other entities
Cash receipts from issuance of bonds
Cash receipts from collection of interest on loans made to other entities

Solution to Review Problem 12.2

It would appear as operating activity because merchandise activity impacts net income as an expense (merchandise costs ultimately flow through cost of goods sold on the income statement).
It would appear as financing activity because sale of common stock impacts owners’ equity.
It would appear as investing activity because purchase of equipment impacts noncurrent assets.
It would appear as operating activity because sales activity impacts net income as revenue.
It would appear as financing activity because dividend payments impact owners’ equity.
It would appear as operating activity because employee payroll activity impacts net income as an expense.
It would appear as operating activity because interest payments impact net income as an expense.
It would appear as investing activity because principal collections impact noncurrent assets.
It would appear as financing activity because bond issuance activity impacts noncurrent liabilities.
It would appear as operating activity because interest received impacts net income as revenue.