Operating Activities Definition Examples Why It Is Important

Operating Activities Definition

Explanation

Fundamental activities of a business that can directly affect the company’s profitability and are mostly the primary unit of the company are classified as the operating activities. Additionally, maintenance and administrative activities also fall under the same head.These activities like sales, marketing, and customer service can be a part of operating activities. They help generate quarterly or annual revenue through which a company’s cost-effectiveness can be determined.These activities can be found under the head of Operating activities in the financial statementsCompany’s Financial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more like cash flow statementCash Flow StatementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more and income statementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more.Other activities are found in these financial statements, namely Financing activities or Investing activities. They are not directly linked with the current profitabilityProfitabilityProfitability refers to a company’s ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company’s performance.read more; instead, they help the company function in the long haul.Cash flows reflect the inflows and outflows from the operating activities in the company’s financial statement, and after the expenses are deducted from the income, we get Operating IncomeOperating IncomeOperating Income, also known as EBIT or Recurring Profit, is an important yardstick of profit measurement and reflects the operating performance of the business. It doesn’t take into consideration non-operating gains or losses suffered by businesses, the impact of financial leverage, and tax factors. It is calculated as the difference between Gross Profit and Operating Expenses of the business.read more.Cash flows from operating activities may act as a financial parameter for analysts and investors to determine the company’s functionality.Operating cash flow can determine the capacity of the company to repay the current expenses like labor wages, administrative expensesAdministrative ExpensesAdministrative expenses are indirect costs incurred by a business that are not directly related to the manufacturing, production, or sale of goods or services provided, but are necessary for the smooth functioning of business operations, such as information technology, finance & accounts.read more, and many more.

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What is Included in Operating Activities?

It includes two sections Operating RevenueOperating RevenueOperating revenue is defined as revenue earned by an individual, corporation, or organization from the core activities that they undertake on a regular basis. There are several methods to earn revenue, but operational revenue is earned by the core business activities that the organization undertakes in its daily operations.read more and Operating ExpensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more, through which we will get to operating income. Let us understand these two heads with the activities categorized under each of them;

#1 – Operating Expenses (Cash outflow)

Employee Salary PaymentsInterest expenseInterest ExpenseInterest expense is the amount of interest payable on any borrowings, such as loans, bonds, or other lines of credit, and the costs associated with it are shown on the income statement as interest expense.read more to the creditorsInterest on Loan and DividendsTaxesLawsuit fine or fees for legal settlementsAdvertising Expenses

#2 – Operating Income (Cash Inflow)

Cash SalesInvestment IncomeInvestment IncomeInvestment income is the earnings made from allocating funds in financial instruments or assets like securities, mutual funds, bonds, property, etc. It includes dividends on bonds and interest received on bank deposits, profits and capital gain from the sale of real estate and securities. read moreAccounts ReceivablesAccounts ReceivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year.
read moreRefunds from SuppliersSettlement of Insurance or legal lawsuit claims

These are only some examples of the operating costs and revenue listed above; where after deducting the operating expense from the operating income, we can get to the Net Operating Revenue.

Example of Operating Activities

Let us see an example to understand the concept in an illustrative manner; below is the data available from its financial statements of Tesla. First, let us see what kind of operating activities a company like Tesla reports.

Solution

Step 1: Let us calculate Total funds from operation i.e Net Income + Depreciation, Depletion & amortization + Other funds which comes to -1063 + 1901 + 1201 = 2039

Step 2: Now we calculate changes in working capital i.e. Receivables + Inventories + Accounts PayableAccounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more + Other assets/liabilities which comes to (-497) + (-1238) + 1723 + 70 = 58

Step 3: And finally, to calculate the Net Operating Cashflow we have to add Total funds from operationsFunds From OperationsFFO (Funds from Operations) is a term used to describe the cash flows generated by Real Estate Investment Trusts (REITs). It is calculated by deducting interest income and gains on asset sales from net income for the period and adding interest expense, depreciation, and losses on asset sales.read more + Networking capital = 2039 + 58 = 2097

So, 2097 is the Net Operating cash flow for Tesla for that period.

Why are Operating Activities Important?

The importance of Operating activities, regardless of any business, is imperative to maximize the revenue of the companyMaximize The Revenue Of The CompanyRevenue maximization is the method of maximizing a company’s sales by employing methods such as advertising, sales promotion, demos and test samples, campaigns, references. It aims to capture a larger market share in an industry. Technically, revenue is maximized when MR (Marginal Revenue) equals zero.read more.Operating cash flow is an important benchmark for an analyst to determine the company’s financial stability using its core business activities.Furthermore, it helps to analyze the expense bearing capacity of the company, i.e., if the company can meet the expenses like labor costLabor CostCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.read more or debt repayment. It is an important tool for the creditors to review the performance and for most investors looking for a prospective potential investment in the company.
Since the company can track and examine the operating expenses from this particular head, it also helps the decision-makers to check the inflows and outflows of the company’s funds, which assists them in maintaining operational efficiency and enough liquidity for the necessary needs of the business.It also helps the board make important management decisions for the company. If there is enough cash available, the company can plan a new product launch or buy back certain shares, which will create a very strong financial position in the market. On the contrary, if there is a cash crunch, the company can delay some of its expansionary actions.In a way, positive cash flow from operationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more is a good sign for the business and company’s flourishment, and it acts as an additional tool other than EBITDAEBITDAEBITDA refers to earnings of the business before deducting interest expense, tax expense, depreciation and amortization expenses, and is used to see the actual business earnings and performance-based only from the core operations of the business, as well as to compare the business’s performance with that of its competitors.read more and Net income to determine the income potential of a company.

Conclusion

Operating activities are the core activities of any company like Sales, administration, marketing, and some other depending on the company’s operations; this activity and the operating income assist us in analyzing any company from the investment or functional perspective.