Operating, financing and investing activities are the three classes a statement of cash flows sorts every cash receipt and cash payment into. The three are not built the same way. Investing and financing are each defined affirmatively, by a list of receipts and a list of payments the standard names, while operating is the residual class that takes every receipt and payment those two lists do not claim.
The instruction to sort is one sentence: a statement of cash flows shall classify cash receipts and cash payments as resulting from investing, financing, or operating activities (FASB, Statement of Financial Accounting Standards No. 95, paragraph 14). Statement No. 95 is where that wording was written and is no longer its live address, because all then-existing non-SEC accounting and reporting standards were superseded on the effective date of Statement No. 168 apart from a short named list (FASB Statement of Financial Accounting Standards No. 168, paragraph 15). Topic 230 of the Codification carries the guidance now, and what the finished statement has to report is set out in the cash flow statement.
Investing Activities
Investing activities include making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other productive assets, meaning assets held for or used in the production of goods or services, other than materials that are part of inventory (FASB, Statement of Financial Accounting Standards No. 95, paragraph 15).
The receipts list covers collections or sales of loans the entity made and of other entities’ debt instruments, sales of equity instruments of other entities and returns of investment in those instruments, sales of property, plant, and equipment and other productive assets, and sales of loans that were not specifically acquired for resale (FASB Accounting Standards Update 2016-15, ASC 230-10-45-12).
The payments list runs from disbursements for loans the entity makes and payments to acquire other entities’ debt and equity instruments, through payments at or near the time of purchase for productive assets, including interest capitalized as part of their cost (FASB Accounting Standards Update 2016-15, ASC 230-10-45-13). The carve-outs inside those two lists, including the seller-financed purchase that splits across the investing and financing sections, are worked through in investing activities.
Financing Activities
Financing activities include obtaining resources from owners and providing them with a return on, and a return of, their investment, borrowing money and repaying amounts borrowed or otherwise settling the obligation, and obtaining and paying for other resources obtained from creditors on long-term credit (FASB, Statement of Financial Accounting Standards No. 95, paragraph 18).
The receipts list opens with proceeds from issuing equity instruments and proceeds from issuing bonds, mortgages, notes and other short-term or long-term borrowing, and for a not-for-profit client it also reaches contributions and investment income that by donor stipulation are restricted to acquiring, constructing or improving long-lived assets or to a donor-restricted endowment fund (FASB Accounting Standards Update 2016-14, ASC 230-10-45-14).
The payments list runs from dividends and other distributions to owners, including outlays to reacquire the entity’s own equity instruments, through repayments of amounts borrowed and other principal payments to creditors who have extended long-term credit, to payments for debt issue costs (FASB Accounting Standards Update 2016-15, ASC 230-10-45-15).
Operating Activities, the Residual Class
Operating activities include all transactions and other events that are not defined as investing or financing activities in paragraphs 15 through 20, and they generally involve producing and delivering goods and providing services (FASB, Statement of Financial Accounting Standards No. 95, paragraph 21). The class is defined by exclusion, and the standard’s own operating lists then illustrate what survives it, a payment to a supplier for goods held for resale being one. Those lists, and the ordered test for an item carrying aspects of more than one class, are in operating activities.
What Belongs in None of the Three
A transaction that moves no cash lands in none of them. Investing and financing activity that affects recognized assets or liabilities without producing a cash receipt or payment in the period goes into related disclosures instead of the statement, and where a transaction is part cash and part noncash, only the cash portion is reported (FASB, Statement of Financial Accounting Standards No. 95, paragraph 32). The standard’s own examples of those noncash transactions are set out in the cash flow statement.
Where the Sort Goes Wrong
A tempting shortcut is to read the class off the balance sheet, sending noncurrent assets to investing, long-term debt and equity to financing, and everything current to operating. It breaks in both directions. Interest paid to a lender is an operating outflow even though the liability behind it is long-term (FASB Accounting Standards Update 2016-15, ASC 230-10-45-17), and a loan the client makes to someone else is an investing outflow even though no productive asset was bought. Split transactions are the other failure, since dividends move opposite ways depending on which direction they flow.
Common Questions
Each class is about a different counterparty, and two of them are set by list. Investing covers dealings in loans the entity makes, in other entities’ debt and equity instruments, and in its own productive assets. Financing covers dealings with the people who fund it, its owners and the creditors it borrows from. Operating is whatever those two lists leave, which is why an unfamiliar receipt is tested against investing and financing first.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can grade that classification work on its own files through a trial task before a client engagement depends on it.
