Cash used to invest in and grow the business
Cash Flow from Investing Activities is the section of a company’s cash flow statement that displays how much money has been used in (or generated from) making investments during a specific time period. Investing activities include purchases of long-term assets (such as property, plant, and equipment), acquisitions of other businesses, and investments in marketable securities (stocks and bonds).
What are Investing Activities in Accounting?
Let’s look at an example of what investing activities include. In this section of the cash flow statement, there can be a wide range of items listed and included, so it’s important to know how investing activities are handled in accounting.
Investing activities can include:
- Purchase of property plant, and equipment (PP&E), also known as capital expenditures
- Proceeds from the sale of PP&E
- Acquisitions of other businesses or companies
- Proceeds from the sale of other businesses (divestitures)
- Purchases of marketable securities (i.e., stocks, bonds, etc.)
- Proceeds from the sale of marketable securities
There are more items than just those listed above that can be included, and every company is different. The only sure way to know what’s included is to look at the balance sheet and analyze any differences between non-current assets over the two periods. Any changes in the values of these long-term assets (other than the impact of depreciation) mean there will be investing items to display on the cash flow statement.
Cash Flow from Investing Activities Example
Let’s look at an example using Amazon’s 2017 financial statements. As you can see below, investing activities include five different items, which total to arrive at the net cash provided by (used in) investing. Let’s take a closer look at each of these items for Amazon.
Amazon’s investing activities include:
- Outflow: purchase of PP&E including software and website development
- Outflow: purchase of marketable securities
- Outflow: acquisitions, net of cash acquired
- Inflow: proceeds from the sale of property and equipment
- Inflow: proceeds from the sale of marketable securities
As you can see in Amazon’s numbers, the main uses of cash for investing have been in purchasing property/equipment/software/websites, acquiring other businesses, and buying marketable securities (stocks and bonds).
It’s also important to point out that the purchase of PP&E (CapEx) has been fairly proportional to depreciation, which indicates the company is consistently reinvesting to keep its assets in good shape.
What Do Investing Activities Not Include?
Now that you have a solid understanding of what’s included, let’s look at what’s not included.
Not included items are:
- Interest payments or dividends
- Debt, equity, or other forms of financing
- Depreciation of capital assets (even though the purchase of these assets is part of investing)
- All income and expenses related to normal business operations
Applications in Financial Modeling
In financial modeling, it’s critical to have a solid understanding of how to build the investing section of the cash flow statement. The main component is usually CapEx, but there can also be acquisitions of other businesses. This section is usually pretty straightforward.
Below are an example and screenshot of what this section looks like in a financial model. Notice how every year the company has “Investments in Property & Equipment,” which are its capital expenditures. There are no acquisitions (“Investments in Businesses”) in any of the years; however, it is there as a placeholder.
Image: CFI’s financial modeling classes.
Additional Resources
Thank you for reading this guide to Investing Activities. To continue learning and progressing your career, these additional CFI resources will be helpful:
Generally accepted accounting principles, or GAAP, established by the Financial Accounting Standards Board, make provisions for various types of investment activities, including the distribution of dividends. In order for companies to provide accurate and up-to-date records regarding operating activity on dividends, these accounting principles must be observed. Reporting this activity is also required under International Financial Reporting Standards, which differ somewhat from GAAP.
Financing
-
When a company pays out dividends to its shareholders, this action is considered a financing activity under GAAP. Because of this, it is reported as such on the company's statement of cash flows. The statement of cash flows generally consists of three primary sections. In addition to the financing activities section, the operating and investing activities of a company are also reported. GAAP differs from International Financial Reporting Standards in that IFRS allows cash paid out to shareholders to be reported as either an operating activity or a financing activity.
Dividends Received
-
Dividends received by a company for its own investments are reported as an operating activity under GAAP. An operating activity is any activity engaged in by a company that has a direct impact on cash flow, whether it is money coming in or money going out from the company. Dividends received are an indication of income coming into the company as they are paid out as a result of the company's own financial investment portfolio.
Accounting
-
Accounting for the dividends it receives, a company will need to enter the information in its general ledger to make sure that it is properly accounted for on its books. Dividends received are first reported as a debit to cash in the general ledger. A corresponding entry must then be credited to the ledger as dividend revenue. These entries are recorded twice in order to comply with GAAP as part of the double-entry system.
Importance
-
The importance of reporting operating, financing and investing activities in a consistent manner in accordance with GAAP should not be overlooked. Companies have manipulated revenue recognition and used it to their financial advantage. GAAP requirements for the reporting of dividends received and paid help to prevent companies from falling prey to the temptation to manipulate their books. When revenue is reported, it has an impact on a company's tax reporting. A company's motives for deferring revenue reporting or classifying as something other than revenue stem from a desire to avoid paying taxes on that revenue. GAAP requirements are designed to prevent this from occurring.
Learning Objective
- Describe the three categories of cash flows.
Question: What are the three types of cash flows presented on the statement of cash flows?
Answer: Cash flows are classified as operating, investing, or financing activities on the statement of cash flows, depending on the nature of the transaction. Each of these three classifications is defined as follows.
- Operating activitiesA section of the statement of cash flows that includes cash activities related to net income, such as cash receipts from sales revenue and cash payments for merchandise. include cash activities related to net income. For example, cash generated from the sale of goods (revenue) and cash paid for merchandise (expense) are operating activities because revenues and expenses are included in net income.
- Investing activitiesA section of the statement of cash flows that includes cash activities related to noncurrent assets, such as cash receipts from the sale of equipment and cash payments for the purchase of long-term investments. include cash activities related to noncurrent assets. Noncurrent assets include (1) long-term investments; (2) property, plant, and equipment; and (3) the principal amount of loans made to other entities. For example, cash generated from the sale of land and cash paid for an investment in another company are included in this category. (Note that interest received from loans is included in operating activities.)
- Financing activitiesA section of the statement of cash flows that includes cash activities related to noncurrent liabilities and owners’ equity, such as cash receipts from the issuance of bonds and cash payments for the repurchase of common stock. include cash activities related to noncurrent liabilities and owners’ equity. Noncurrent liabilities and owners’ equity items include (1) the principal amount of long-term debt, (2) stock sales and repurchases, and (3) dividend payments. (Note that interest paid on long-term debt is included in operating activities.)
Figure 12.1 "Examples of Cash Flows from Operating, Investing, and Financing Activities" shows examples of cash flow activities that generate cash or require cash outflows within a period. Figure 12.2 "Examples of Cash Flow Activity by Category" presents a more comprehensive list of examples of items typically included in operating, investing, and financing sections of the statement of cash flows.
Figure 12.2 Examples of Cash Flow Activity by Category
*Receipts of cash for dividends from investments and for interest on loans made to other entities are included in operating activities since both items relate to net income. Likewise, payments of cash for interest on loans with a bank or on bonds issued are also included in operating activities because these items also relate to net income.
Question: Which section of the statement of cash flows is regarded by most financial experts to be most important?
Answer: The operating activities section of the statement of cash flows is generally regarded as the most important section since it provides cash flow information related to the daily operations of the business. This section answers the question, “how much cash did we generate from the daily activities of our core business?” Owners, creditors, and managers are most interested in cash flow generated from daily activities rather than from a one-time issuance of stock or a one-time sale of land. The operating activities section allows stakeholders to assess the ongoing viability of the company. We discuss how to use cash flow information to evaluate organizations later in the chapter.
Cash Activity at Home Depot and Lowe’s
The Home Depot. Inc., and Lowe’s Companies, Inc., are large home improvement retail companies with stores throughout North America. A review of the statements of cash flows for both companies reveals the following cash activity. Positive amounts are cash inflows, and negative amounts are cash outflows.
This information shows both companies generated significant amounts of cash from daily operating activities; $4,600,000,000 for The Home Depot and $3,900,000,000 for Lowe’s. It is interesting to note both companies spent significant amounts of cash to acquire property and equipment and long-term investments as reflected in the negative investing activities amounts. For both companies, a significant amount of cash outflows from financing activities were for the repurchase of common stock. Apparently, both companies chose to return cash to owners by repurchasing stock.
Key Takeaway
- The three categories of cash flows are operating activities, investing activities, and financing activities. Operating activities include cash activities related to net income. Investing activities include cash activities related to noncurrent assets. Financing activities include cash activities related to noncurrent liabilities and owners’ equity.
Identify whether each of the following items would appear in the operating, investing, or financing activities section of the statement of cash flows. Explain your answer for each item.
- Cash payments for purchases of merchandise
- Cash receipts from sale of common stock
- Cash payments for equipment
- Cash receipts from sales of goods
- Cash dividends paid to shareholders
- Cash payments to employees
- Cash payments to lenders for interest on loans
- Cash receipts from collection of principal for loans made to other entities
- Cash receipts from issuance of bonds
- Cash receipts from collection of interest on loans made to other entities
Solution to Review Problem 12.2
- It would appear as operating activity because merchandise activity impacts net income as an expense (merchandise costs ultimately flow through cost of goods sold on the income statement).
- It would appear as financing activity because sale of common stock impacts owners’ equity.
- It would appear as investing activity because purchase of equipment impacts noncurrent assets.
- It would appear as operating activity because sales activity impacts net income as revenue.
- It would appear as financing activity because dividend payments impact owners’ equity.
- It would appear as operating activity because employee payroll activity impacts net income as an expense.
- It would appear as operating activity because interest payments impact net income as an expense.
- It would appear as investing activity because principal collections impact noncurrent assets.
- It would appear as financing activity because bond issuance activity impacts noncurrent liabilities.
- It would appear as operating activity because interest received impacts net income as revenue.