6.7 Classification of cash flows
ASC 230 identifies three classes of cash flows—investing, financing, and operating—and requires a reporting entity to classify each discrete cash receipt and cash payment (or identifiable sources or uses therein) in one of these three classes. The classification is based on the nature of the cash flow, without regard to whether a cash flow stems from another item (hereafter referred to as the “nature principle”). A cash flow is first evaluated to determine if it meets either the definition of an investing or financing cash flow. If a cash flow does not meet the definition of an investing activity or a financing activity, the cash flow is classified as an operating activity. Cash flows from operating activities are generally the cash effects of events that enter into the determination of net income. However, see FSP 6.7.3 for a discussion of events that enter into the determination of net income that are not classified as operating cash flows.
The definitions of the activity classes within ASC 230, combined with its waterfall model, results in a bias toward classifying cash flows as operating activities. When determining the appropriate classification, the FASB acknowledged that, in some situations, a reasonable case can be made for alternative classifications.
6.7.1 Investing activities
Investing activities include making and collecting loans, purchasing and selling debt or equity instruments of other reporting entities, and acquiring and disposing of property, plant, and equipment and other productive assets used in the production of goods or services.
Following the principles in ASC 230-10-45, the following items should be classified as investing activities:
- Gross cash receipts or cash payments resulting from the acquisition or sale of debt securities (classified as available-for-sale or held-to-maturity) or equity securities of other reporting entities
However, interest income or dividend income received in cash on such investment securities is an operating cash inflow. Investments accounted for as trading securities under ASC 320-10, when there is a stated intent to buy and sell securities with the objective of generating trading profits, should be classified as operating activities rather than investing activities.
Cash flows from these loans should continue to be classified as cash flows from investing activities, even if the reporting entity subsequently reclassifies the loans as held for sale (this is a concept known as symmetry).
6.7.2 Financing activities—updated January 2025
Financing activities include borrowing money and repaying or settling the obligation, obtaining equity from owners, as well as providing owners with a return on, or return of, their investment.
Following the principles in ASC 230-10-45, the following items should be classified as financing activities:
- Payments for debt and stock issue costs (e.g., third-party costs)
- Payments for debt prepayment or debt extinguishment costs (see FSP 6.8.7)
- Proceeds from failed sale-leaseback transactions
- Proceeds from issuing debt
- Payments on seller-financed debt related to the purchase of property, plant, and equipment and other productive assets
6.7.3 Operating activities
Cash flows that are not investing or financing activities are operating cash flows. Typically, operating cash flows are receipts and payments that enter into the determination of net income.
ASC 230 defines operating activities.
Excerpt from ASC 230-10-20
Cash flows from operating are generally the cash effects of transactions and other events that enter into the determination of net income.
Following the principles in ASC 230-10-45-16 to ASC 230-10-45-17, the following items should be classified as operating activities:
- Receipts from customers for sales of goods and/or services, as well as receipts from short-term and long-term receivables from customers under normal trade terms that arose from sales of goods and/or services
- Interest and dividend receipts related to investments in other reporting entities or deposits with financial institutions (i.e., returns on investment)
Cash flows should continue to be classified as operating activities, even if the reporting entity subsequently reclassifies the loans to be held for long-term investment.
ASC 350-40-45-3 requires an entity to classify payments for capitalized implementation costs in the statement of cash flows in the same manner as payments made for fees associated with the hosting element, which would typically be operating cash flows.
Figure FSP 6-2 includes common transactions that enter into the determination of net income, but generally are not classified as operating cash flows.
Figure FSP 6-2
Common transactions that enter into the determination of net income, but generally are not classified as operating cash flows
Financing, investing, and operating activities || Preparation of Financial Statements || Bcis Notes
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.
The three categories of cash flows are operating activities, investing activities, and financing activities.
Financing activities
Financing activities include transactions involving debt, equity, and dividends. Cash flow from financing activities provides investors with insight into a company’s financial strength and how well a company’s capital structure is managed. Financing activities are transactions or business events that affect long-term liabilities and equity. In other words, financing activities are transactions with creditors or investors used to fund either company operations or expansions. These transactions are the third set of cash activities displayed on the statement of cash flows.
Example
Financing activities include both cash inflows and outflows from creditors and investors. Cash inflows from creditors usually consist of new loans issued to the company, while cash outflows from creditors include loan and interest payments. Issuances of bonds and bond payments have also consisted of financing activities.
Cash inflows from investors occur from newly issued stock or contributions from partners; whereas, cash outflows from investors consist of dividends and owner distributions.
Not all financing activities affect cash, however. Some projects are financed directly. Take a company building a new building for example. If the building is completely financed by a mortgage, the cash account is never changed. The liability account is increased and the building account is increased.
Investing activities
Investing activities are the second main category of net cash activities listed on the statement of cash flows and consist of buying and selling long-term assets and other investments. In other words, this is the net amount of cash received and paid during an accounting period for long-term assets and investments. You can think of these activities as the money a company uses to invest in itself or the money it makes from its investments.
Example
Here’s a shortlist of common cash inflows and outflows listing in the investing section of the cash flows statement.
Inflows
- Cash collected from:
- Selling trading, held for sale, and available for sale securities
- Selling discounted notes
- Selling long-term productive assets
- Collecting principle on the third party notes that don’t generate sales
Outflows
- Cash paid to:
- Purchase trading, held for sale, and available for sale securities
- Purchase long-term productive assets
- Pay principle on the third party notes that don’t generate sales
Operating activities
Operating activities consist of principle activities that a company performs to earn income. In other words, these are the primary business operations that a company performs to earn revenue. This is what the company is in business to do. These cash inflows and outflows from operating activities are reported on two different financial statements. First, they show up on the income statement and are used to compute net income. Second, they are reported on the statement of cash flows. This statement shows how cash from three main sources (operating activities, investing activities, and financing activities) increased or decreased during the period. Let’s look at an example.
Example
Take Best Buy for instance. Best Buy purchases electronics and appliances from manufacturers and sells them to customers. So any activity that is involved in Best Buy purchasing inventory or selling inventory to customers is considered an operating activity. This can even include administrative expenses. As long as the activity is related to selling goods to customers, it is considered an operating activity.
Best Buy also has activities that are not directly related to selling products to customers like selling fixed assets, getting loans from banks, or paying dividends to shareholders. None of these activities are considered operating activities because they can’t be related back to Best Buy’s principal business activity: selling products to customers. These activities would either be considered investing or financing activities. Sometimes these three categories can get confusing.
Just remember that principle activities include any cash inflows or outflows that relate to the primary business activity or the activity that the business performs to earn a profit. Every other activity is not considered an operating activity.
- and operating activities
- Financing
- investing
- Preparation of Financial Statements
https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/financial_statement_/financial_statement___18_US/chapter_6_statement__US/67_class.htmlhttps://bcisnotes.com/fourthsemester/financing-investing-and-operating-activities-preparation-of-financial-statements-bcis-notes/
