Operating Activities
Chapter Forty-Nine
Syllabus topic 4, "Classification of cash flows"
Pages 134 to 136 of 162
In one line
Operating cash flows are the cash consequences of the transactions that determine the net profit, less the ones whose cash effect is investing or financing.
Why they matter most: paragraph 11
The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise, pay dividends, repay loans and make new investments without recourse to external sources of financing.
Four demands are named in that sentence, and they are the four tests to which the operating figure is put.
| Can the operating cash flow | |
|---|---|
| 1 | Maintain the operating capability, meaning replace the assets as they wear out |
| 2 | Pay dividends |
| 3 | Repay loans |
| 4 | Make new investments |
All four without recourse to external sources of financing. A company whose operating cash flow does all four finances itself. That is what the figure is for, and a comment on a cash flow statement should say which of the four it covers.
And the paragraph's second sentence: information about the specific components of historical operating cash flows is useful in forecasting future operating cash flows. So the components are worth showing, not merely the total.
The seven examples: paragraph 12
AS 3's own list, letter by letter.
| Example | |
|---|---|
| (a) | Cash receipts from the sale of goods and the rendering of services |
| (b) | Cash receipts from royalties, fees, commissions and other revenue |
| (c) | Cash payments to suppliers for goods and services |
| (d) | Cash payments to and on behalf of employees |
| (e) | Cash receipts and payments of an insurance enterprise for premiums and claims, annuities and other policy benefits |
| (f) | Cash payments or refunds of income taxes, unless they can be specifically identified with financing and investing activities |
| (g) | Cash receipts and payments relating to futures, forward, option and swap contracts held for dealing or trading purposes |
Item (f) is the tax rule and the chapter on taxes takes it in full. Item (g) is the trading exception applied to derivatives, and item (e) is the reason an insurance company's premiums are operating rather than financing.
The rule that catches students: paragraph 13
Some transactions, such as the sale of an item of plant, may give rise to a gain or loss which is included in the determination of net profit or loss. However, the cash flows relating to such transactions are cash flows from investing activities.
Two consequences, and both are examinable.
- The whole sale proceeds go to investing, not the book value and not the gain.
- Under the indirect method the gain must be deducted from net profit, and a loss added back, because the profit figure contains something whose cash is reported elsewhere. Leaving it in counts the same money twice.
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