What are the Classification of Cash Flow?

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.

Operating Activities:
These are the company's core business activities, such as manufacturing, distributing,
marketing and selling a product or service. Operating activities should generally provide the
majority of a company's cash flow and largely determine whether a company is profitable.

What does Operating Cash Flow (OCF) mean?

Operating cash flow is a measure of the cash flow generated by a firm in the course of its
normal business operation. It indicates whether the cash flow generated by the firm is sufficient
to maintain and grow its operations or whether external financing is required. It can be
calculated directly by taking the balance of operating revenue and expense items or indirectly
by adjusting the net income for depreciation and changes in working capital.

A company's cash flow will increase or decrease from:

Operating activities: core business

Investing activities: capital expenditure, investments and acquisitions

Financing activities: raising funds and repaying debts

Operating cash flows provide the amount of cash that a firm generates from its core business as
opposed to peripheral activities, such as investing and borrowing. It provides a clearer picture
of the current reality of the firm's business operations. For example, large sales may not
translate into bigger cash flows if accounts receivable are equally large or if there is a huge
depreciation of several fixed assets that results in a lower net income.

Operating Cash Flow = EBIT + Depreciation - Taxes

This gives insight into how a firm manages its short-term capital and the amount of cash it
generates from revenues, excluding costs associated with long-term investments in capital and
securities. A strong OCF implies a stable net income and the ability to weather downturns in the
industry. These are highly valued by investors and uncover the true profitability of a firm. Cash
flow is harder to manipulate and negative operating cash flows forecast sickness. Chronic
earning manipulation can be spotted with the use of operating cash flows.

Many business owners mistakenly interchange the metrics of net income with operating cash
flow. The major difference between the two is a company's required investment in working
capital. This will have a significant impact on operating cash flows. Take, for example, two
companies that have the same level of net income but Company 1 collects its account
receivables significantly slower than Company 2. Obviously, Company 1 will have much lower
operating cash flows.

Finally, OCF will affect a buyer's assessment of a potential acquisition target. Lower operating
cash flows will impact a buyer's ability to service debt obtained for the acquisition and will also
reduce investment returns achieved by the acquirer. 

Investing Activities:
Cash flow from Investing activities is an item on the cash flow statement that reports
the aggregate change in a company's cash position resulting from any gains (or losses)
from investments in the financial markets and operating subsidiaries and changes
resulting from amounts spent oninvestments in capital assets.

Cash flow analysis is a critical process for both companies and investors. It's also a
complex process that can leave the average investor with the feeling that delegating
security analysis to a competent financial advisor just might be a good idea. If you aren't
an accountant or a Chartered Financial Analyst, but you want to have a better
understanding of what "cash flow from investing" means to business and investors alike,
there are just a few basic concepts that you need to understand. (For more on
becoming a Chartered Financial Analyst, see An Introduction To The CFA Designation.)

TUTORIAL: Cash Flow Indicator Ratios

Cash Flow Components

Corporate cash flow statements include three components:

 Cash flows from operating activities

 Cash flows from investing activities
 Cash flows from financing activities

Cash flows from operating activities refers to money generated by a company's

core business activities. This number highlights the firm's ability (or inability) to make a
profit. While it provides good insight into whether or not the firm is making money, the
other components of the cash flow statement also need to be taken into consideration in
order to develop a more complete picture of the company's health.

Consider "cash flows from investing." Intuitively, cash flows from investing may sound
like the amount of money a company generates from investments it has made, but the
accountants who fill out corporate balance sheets are generally not referring to the
number of shares of IBM the company has bought or the number of municipal bonds it
has sold. Rather, from a corporate perspective, they are generally referring to money
made or spent on long-term assets the company has purchased or sold. (For related
reading, see Analyze Cash Flow The Easy Way.)

Upgrading equipment and buying another company to take over its operations and gain
access to its clients and technology are investment activities from a corporation's point
of view. Both of these activities cause companies to spend money, which is captured on
a cash flow statement as negative cash flow. Similarly, if a company sells off old
equipment or sells a division of its operations to another firm, these activities are also
captured on paper as income from investing.

Cash flow from financing activities measures the flow of cash between a firm and its
owners and creditors. Corporations often borrow money to fund their operations,
acquire another company or make other major purchases. Timely operational
expenditures, such as meeting payroll requirements, would be one reason for cash-flow
financing. Companies are essentially borrowing from cash flows they expect to receive
in the future by giving another company the rights to an agreed portion of
their receivables. This allows companies to obtain financing today, rather than at some
point in the future.

What It Means to an Investor

Cash flow from operating activities is an important source of data for investors. Net
income, depreciation and amortization, as well as changes in working capital, are
included in this section of the corporate cash flow statement. The net number can be
positive or negative.

Financing Activities:
A category in a company's cash flow statement that accounts for
 external activitiesthat allow a firm to raise capital and repay investors, such as
issuing cash dividends, adding or changing loans or issuing more stock. Cash flow
from financing activitiesshows investors the company's financial strength.

Cash flows from financing activities is a line item in the statement of cash flows. This
statement is one of the documents comprising a company's financial statements. The line
item contains the sum total of the changes that a company experienced during a designated
reporting period that were caused by transactions with owners or lenders to either:

 Provide long-term funds to the company; or

 To return those funds to the owners or lenders. 

If the company is a not-for-profit, then you would also include in this line item all
contributions from donors where the funds are to be used only for long-term purposes.

Items that may be included in the financing activities line item are:

 Sale of stock (positive cash flow)

 Repurchase of company stock (negative cash flow)
 Issuance of debt, such as bonds (positive cash flow)
 Repayment of debt (negative cash flow)
 Payment of dividends (negative cash flow)
 Donor contributions restricted to long-term use (positive cash flow)

The cash flows from financing activities line item is one of the more important items on the
statement of cash flows, for it can represent a substantial source or use of cash that
significantly offsets any positive or negative amounts of cash flow generated from
operations.

On the other hand, a smaller organization that has no debt and pays no dividends may find
that it has no financing activities in a reporting period, and so does not need to include this
line item in its statement of cash flows.

You should delve into the reasons for a large positive or negative balance in the cash flows
from financing activities, since it can, for example, denote the need for a large loan to
support ongoing negative cash flows from operations. Thus, large amounts in this line item
can be considered a trigger for a more detailed investigation.

The statement of cash flows is divided into three sections:

A. Financing activities
 B. Operating activities

C. Investing activities

A. Cash flow from financing activities (CFF)

CFF is cash flow that comes into play from generating or letting cash through the
issuance of additional equity, short or long-term debt for the firm's operations. This
covers:

(a) Cash inflow (+)

1. Sale of equity securities

2. Issuance of debt securities

(b) Cash outflow (-)

1. Dividends to shareholders
2. Redemption of long-term debt
3. Redemption of capital stock

Reporting Noncash Investing and Financing Transactions Data for the Statement of
cash flows(SOCF) is derived from three places:

 Comparative balance sheets

 Current income statements
 Selected transaction data
B. Cash Flow from Operating Activities (CFO)
CFO is cash flow that comes into play from regular operations such as revenues and
cash operating expenses net of taxes. This category covers:

(a) Cash inflow (+)

1. Revenue from sale of goods and services

2. Dividends (from equities of other entities)
3. Interest (from debt instruments of other entities)

(b) Cash outflow (-)

1. Payments to lenders
2. Payments to employees
3. Payments to suppliers
4. Payments to government
5. Payments for other expenses

C. Cash Flow from Investing Activities (CFI)

CFI is cash flow that comes to play through investment activities such as the
acquisition or disposition of current and fixed assets. This category covers:
 (a) Cash inflow (+)

1. Sale of property, plant and equipment

2. Sale of debt or equity securities (other entities)
3. Collection of principal on loans to other entities

(b) Cash outflow (-)

1. Purchase of property, plant and equipment

2. Purchase of debt or equity securities (other entities)
3. Lending to other entities

There are however, some investing and financing activities that don't flow through
the Statement of Cash Flow because they do not engage cash transactions.

Simple instances of this category are:

1. Acquisition of assets through capital leases

2. Acquisition of long-term assets by issuing notes payable
3. Conversion of debt to equity
4. Conversion of preferred equity to common equity
5. Acquisition of non-cash assets like patents, licenses in exchange for equity or
securities