Accounting for Operating Activities

Operating Activities

Business processes that generate revenues are called operating activities. There is a direct relationship between operating activities and the company’s cash inflows and outflows. Typical sources of cash inflows are from sold shares, services, or commodities, and revenues from investments. When there is acquisition of equipment, replenishment of stocks, payment of dividends, and settlement of liabilities (loans and debts), cash outflows occur.

In general, the organization’s operating activities refers to the central business processes — production, distributing, and marketing or selling of the goods or services. The said activities generate and utilize most of the company’s cash flows. Since operating activities are concerned with business undertakings where earnings and expenses are created, the net profit and net loss are established using data from them.

Examples of Operating Activities

  • Income or Revenues

The income of the business is derived from activities in the enterprise that generate cash. The two major classifications of these activities are product delivery and service provision. An example of a product delivery is a boutique, which sells its own line of clothes and also re-sells branded apparels supplied by the manufacturer. In that essence, product delivery covers reselling items that are supplied by others and/or selling their own product. On the other hand, an example of providing services is a spa salon that may or may not sell spa treatment products in order to create extra revenues.

  • Marketing

It is fairly common for big enterprises to create advertisements as a way of introducing or promoting their products or services. Examples are TV ads, sample food tastings, training sessions, and recommendations through word of mouth.

  • General and Administrative

Examples under this category are maintenance, accounting, and security. Businesses need people who will maintain their facilities and equipment, utilities for their daily work, accounting personnel, and security to protect the company’s employees and its products.

Cash Flow from Operating Activities

The movement of cash into and out of the company can be monitored or tracked from the statement of cash flows under the cash flows from operating activities. It is important that the management aim their attention at this section since it reflects the capacity of the company to generate revenues, which is a key metric in assessing the financial status and health of the business. In doing so, the net income, depreciation and amortization, changes in working capital, and net cash provided by operating activities are stated and described here.

  • Net Income

As stated in the income statement, the net income will essentially point us to how much the organization allocates for its day-to-day business undertakings.

  • Depreciation and Amortization

A common business expenses, depreciation is the decline of an asset’s value primarily due to wear and tear.  Similar to depreciation that are used for tangible assets, amortization is settling debts, usually in installments, over a certain period.

  • Changes in Working Capital

The formula for the working capital is:

Current Assets — Current Liabilities

Working capital is the amount that the business will have to work on. Changes in the working capital have significant effects on the cash flow. For instance, an increase in the asset balance will result in a decrease in cash flow for operating activities, and vice-versa.

  • Net Cash Provided by Operating Activities

This is the operating cash flow or the remaining cash after all liabilities and expenses are deducted. This is important since it will show how much revenues are generated by the company’s operating activities.

Metrics for Operating Activities

  • Net Profit

Net profit is the total amount of cash generated by operating activities after all that needs to be paid have been settled. The higher the net profit, the better. However, there will be times that the net profit is negative, and this means trouble. To increase the net profit, the management has to consider other approaches wherein there will be an upsurge in revenues while limiting the company’s spending on operating activities.

  • Direct Costs

These can be ascribed to the manufacturing of goods or creation of services. As a metric, direct costs are important since it will aid the management in tracking the expenses that the company incurred while creating and/or delivering the product or service. Unlike the net profit, direct costs should stay as low as possible. If the direct costs exceed the cap for a specific operating activity, it is suggested that the business should consider new suppliers or work on minimizing its operating costs.

  • Operating Margins

Operating margins are earnings that are in terms of percentage of the overall revenue. With this metric, the management can liken or equate its operating efficiency with other enterprises. Is he company under-performing or not?