The inflows and outflows of cash during the year appear in the statement of cash flows in one of three categories: operating, investing, and financing. Explain each category

Answer 1

THE STATEMENT CLASSIFIES THE REASONS FOR THE CHANGE IN CASH
AS AN OPERATING, OR INVESTING, OR FINANCING ACTIVITY

The inflows and outflows of cash during the year appear in the statement of cash flows in one of three categories: operating, investing, and financing.

1 . Operations

A financially healthy company generates sustained cash inflows from selling goods and providing services. Assessed over several years, the cash flow from operations indicates the extent to which operating activities generate more cash than they use. A firm can use the excess cash flow from operations to acquire buildings and equipment, pay dividends, retire long-term debt, and conduct other investing and financing activities.

2 . Investing

The second section of the statement of cash flows shows the amount of cash flow from investing activities. The acquisition of noncurrent assets, particularly property, plant, and equipment, usually represents a major ongoing use of cash. A firm must replace such assets as they wear out or become obsolete, and it must acquire additional noncurrent assets if it is to grow. A firm often obtains part of the cash needed to acquire noncurrent assets from sales of existing noncurrent assets. Such cash inflows seldom, however, cover the cost of new acquisitions. Firms not experiencing rapid growth can often finance capital expenditures with cash flow from operations, while rapidly growing firms must often borrow funds or issue common shares to finance their acquisitions of noncurrent assets.

3 . Financing

Third, a firm obtains cash from borrowing and from issuing common or preferred shares. It uses cash to pay dividends to shareholders, to repay borrowing, and to reacquire outstanding common or preferred shares. These amounts appear as cash flow from financing activities in the statement of cash flows.