Accounting for Financial Activities

Financial Activities

Business undertakings between a company and its creditors and investors are called financing or financial activities. It consists of cash inflows and outflows, or the sourcing and utilization of cash. Enterprises engage in commercial activities in order to expedite the realization of their economic goals. Essentially, financial activities support the company’s transactions and strategic actions.

Components of Financial Activities

Financial activities usually include acquisition or sales of assets, stocks, or goods; issuance of equities, bonds, or debts; payment of dividends; arrangement of loans; and other activities that include financial goals.

  • Acquisition of Stocks or Assets

In purchasing or repurchasing stocks and/or assets, the management sets a ceiling for the amount of resources and time duration for it to be carried out. The entire acquisition process represents a cash outflow, which is equivalent to the overall amount of purchasing or repurchasing the shares or stocks. In addition, this step will show that the company is in a robust and secure financial status.

  • Issuance of Equities, Bonds, or Debts

Organizations issue shares or equities via Initial Public Offering or IPO. Its earnings can be calculated by using this formula:

(Listing Price * Number of Issued Shares) — Investment Banking Fees

Moreover, companies can still issue equities through private business dealings.

Debts are also a part of a company’s financial activities. These are issued through short- and long-term loans, bond sales, and lines of credit. Enterprises benefit from these activities, especially when resolving momentary cash deficiencies or when financing new investments.

  • Paying Dividends

Approval from the management is needed when paying dividends. These are derived from after-tax net income. Usually, organizations pay their dividends quarterly. However, some companies issue one-time dividends.

Financial Statements from Financial Activities

All transactions that are under financial activities are reflected on the Statement of Cash Flows. Generally, the cash flow from financing activities can be calculated using this formula:

Cash Received from Issuing Stock or Debt — Cash Paid as Dividends and Reacquisition of Debt/Stock

In order for the management to determine whether the company’s assets are increasing or decreasing, cash flows are classified as either positive or negative. A positive cash flow signifies that the money going into the business is greater than the money going out of the business. On the other hand, a negative cash flow means that the business is servicing a debt, which spells trouble, or the company is settling dividend payments or reacquiring stocks.

The cash flow from commercial activities covers and quantifies the cash inflows and outflows between the business and its creditors, investors, and owners. For instance, it is indicated in the cash flow statement that there is a positive cash flow for this certain period. This cash flow means that the business generated revenues from issuing stocks, equities, or bonds.

The significance of financial statements from financial activities is that it gives insight on how an entity borrows and pays back its loan or credit, issues stocks, bonds, or equities, and pay dividends. For investors and creditors, the cash flow statement from financial activities will let them know and understand how the business does set its capital from debt and equity sources, and how these sources are settled for a certain period.

Metrics for Financial Activities

The metrics used on financial activities will not only illustrate the overall health of the business, but will also show the cash inflows and outflows and how the company’s resources are being managed for a particular financial activity.

  • Cash Flows that are Free from Debts

With this metric, the management will know the amount of cash flowing in that is not allocated for settling debts. This will give the management a picture of the relationship between the cost of borrowed money and the business returns.

  • Excess Cash

It is a common knowledge that insufficient cash translates to business problems. Having excess cash also has demerits and can affect the company. According to thebusinessferret.com, there will be an upsurge on the cost of capital, a decrease on the return of assets, and an increase in overall risk when companies hold excess cash. The rise and drop of excess cash balance is a good indicator of the health of the business.

  • Return on Assets

This metric can be calculated by using this formula:

Net Operating Income after Tax / Total Assets

To better illustrate the significance of this metric, let’s say that the annual business return after taxation is 10% in contrast with a 15% profit on bonds. This means that the risk of investing all the assets solely on the business is not doing well.

  • Accounts Payable

Accounts payable are the company’s short-term debt that must be settled. These are the total bills that the business must pay, but are not paid yet. In managing the company’s cash flow, it is a must that the management keeps track of its accounts payable. As the business engages in new ventures, there will be invoices that must be compensated and dealt with to avoid cash problems.

  • Accounts Receivable

Accounts receivable is the amount of money that your customers owe you. These are the overall invoices that are not settled yet. On the balance sheet, accounts receivable are considered as assets. Monitoring the accounts receivable is just as important as keeping track of the accounts payable. Even if there is an increase in sales, which translates to expected cash inflows if your clients are not paying their invoices, sooner or later, your business will face financial crisis.