Operating activities are the class of cash flows that generally carries the cash effects of the transactions and other events entering into the determination of net income, and in a statement of cash flows they are reported as the operating section. The class is a residual: any cash receipt or payment that does not stem from a transaction defined as an investing or a financing activity belongs to it. The transactions behind those flows generally involve producing and delivering goods and providing services.
That wording is the original standard’s own, written into Statement of Financial Accounting Standards No. 95, paragraph 21: operating activities include all transactions and other events not defined as investing or financing activities, and their cash flows are generally the cash effects of transactions and other events that enter into the determination of net income (FASB, Statement of Financial Accounting Standards No. 95, paragraph 21).
That Statement is the origin of the wording rather than its live address. It was one of the then-existing non-SEC accounting and reporting standards superseded on the effective date of Statement No. 168, which kept only a short list of named Statements authoritative until each was integrated into the Codification (FASB Statement of Financial Accounting Standards No. 168, paragraph 15). The live address is Topic 230, the statement of cash flows topic in the Codification.
What the other two classes hold, and how the three sections tie to the closing cash total, are set out in the cash flow statement.
What the Standard Names as Operating
Three classes of receipts are listed (FASB Accounting Standards Update 2016-15, ASC 230-10-45-16). Cash receipts from sales of goods or services come first, including receipts from collection or sale of accounts and of notes receivable from customers arising from those sales, so collecting an old invoice is an operating receipt in the period the money lands. The second class is cash receipts from returns on loans, other debt instruments of other entities, and equity securities, meaning interest and dividends received. The third is all other cash receipts that do not stem from transactions defined as investing or financing activities, such as amounts received to settle lawsuits, proceeds of insurance settlements other than those directly related to investing or financing activities, and refunds from suppliers. Specific guidance now classifies those insurance proceeds by the nature of the loss.
Six classes of payments are listed (FASB Accounting Standards Update 2016-15, ASC 230-10-45-17). Payments to acquire materials for manufacture or goods for resale open it, including principal payments on accounts and notes payable to suppliers for those goods. Payments to other suppliers and employees for other goods or services follow. Payments to governments for taxes, duties, fines, and other fees or penalties come next, and that paragraph does not split them by the activity that produced the charge, though specific guidance elsewhere can. Then come payments to lenders and other creditors for interest, and a payment made to settle an asset retirement obligation. The sixth is the residual class of other payments.
How a Borderline Receipt or Payment Gets Assigned
Assignment is an ordered test, not a preference. Where a receipt or payment has aspects of more than one class, classification is determined first by applying specific guidance in the Topic and other applicable Topics, and absent that guidance the entity identifies each separately identifiable source or use on the basis of the nature of the underlying cash flows and classifies each one accordingly (FASB Accounting Standards Update 2016-15, ASC 230-10-45-22). Predominance is the last resort, reached only when the aspects cannot be separated by source or use, and then the classification depends on the activity likely to be the predominant source or use of cash flows for the item (FASB Accounting Standards Update 2016-15, ASC 230-10-45-22A).
Four assignments are worth separating out. A loan payment splits: the interest is an operating outflow under the payments list above, while the repayment of the amount borrowed sits on the financing list, alongside a cash dividend paid to owners. Dividends received run the other way and are an operating receipt.
Costs paid to get out of a borrowing do not follow that interest. Payments for debt prepayment or debt extinguishment costs, including third-party costs, premiums paid, and other fees paid to lenders directly related to the prepayment or extinguishment, excluding accrued interest, are financing outflows (FASB Accounting Standards Update 2016-15, ASC 230-10-45-15).
Insurance money follows the loss rather than the policy. Cash receipts from the settlement of insurance claims, excluding proceeds from corporate-owned and bank-owned life insurance policies, are classified on the basis of the related insurance coverage, that is, the nature of the loss, and a lump-sum settlement is split by the nature of each loss in it (FASB Accounting Standards Update 2016-15, ASC 230-10-45-21B).
A tax payment is not automatically operating either. Cash paid to a tax authority by an employer when withholding shares from an employee’s award for tax-withholding purposes is treated as an outlay to reacquire the entity’s equity instruments, which puts it on the financing list (FASB Accounting Standards Update 2016-15, ASC 230-10-45-15).
Where a Firm Meets the Classification
The call is made per transaction, off the support behind it rather than off the account the entry landed in. A bank line reading “settlement” is not evidence of a class, so the workpapers have to show which loss or contract produced the cash. Once the class is settled the arithmetic is a separate job. The operating subtotal is built line by line in the operating cash flow formula, and the choice of how to present the operating section, along with the interest and income taxes paid disclosure the indirect method forces, belongs to the cash flow statement with the indirect method.
What Operating Activities Are Confused With
Operating income is a subtotal of the income statement, struck on the accrual basis before interest and income tax and defined by where it sits rather than by cash moving, as the equation for operating income sets out.
Operating cash flow is the dollar total this class produces. The class is the set of transactions; the subtotal is what they add up to.
Operating expenses are a cost category on the income statement, recognized when incurred, so an operating expense and an operating cash payment can fall in different periods.
Common Questions
The classes the standard itself names: collections from customers, interest and dividends received, refunds from suppliers, payments to suppliers and employees, taxes paid, interest paid, and settlement of an asset retirement obligation (FASB Accounting Standards Update 2016-15, ASC 230-10-45-16 and ASC 230-10-45-17). Anything on neither list is tested against the investing and financing lists first and lands here only if it fails both.
The same class, named by where it appears: the section of a statement of cash flows that reports these receipts and payments and totals them as net cash provided by, or used in, operating activities.
Operational activities is a loose synonym for the day-to-day running of a business and is not a defined term in the accounting standard. Operating activities is a defined term, and the definition is a classification rule for cash flows rather than a description of what a business does.
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