What Are Financing Activities?
Financing activities refer to business transactions involving long-term liabilities, owners' equity, and short-term debts. The cash flow from financing activities is the net amount of funding a company generates in a given period. It comes from transactions between the company and its investors and creditors.
A business has cash inflow when it receives money from issuing notes payable to its creditors or issuing stocks to investors, and cash outflow when it pays off the debt or distributes dividends to shareholders. Investors and lenders look into a company's cash flow from financing activities to gauge its financial strength. The report also provides insight into how well a business manages its capital.
Don't deal with the overwhelm of creating financial statements for your business. Skynova's accounting software makes generating financial reports a breeze. Keep reading to learn more about financing activities and why they're important.
What Is the Cash Flow From Financing Activities?
The cash flow from financing activities includes funds businesses receive from borrowing or raising capital. The cash inflow or outflow from these activities is reflected in the company's cash flow statement. A cash flow statement, often referred to as a statement of cash flows, shows how much cash is raised and spent during a given period. The main categories found in a cash flow statement are operating activities, investing activities, and financing activities.
In the financing activities section of the statement of cash flows, businesses list the cash inflows and cash outflows from:
- Borrowing and repaying short-term loans
- Borrowing and repaying long-term loans and other long-term liabilities
- Issuing or repurchasing their own shares of common and preferred stock
- Paying cash dividends on their capital stock
The cash flow from financing activities follows the movement of cash between a business and its owners, investors, and lenders. It shows how the company manages its capital to finance its operations, pay off its debts, and disburse dividends.
Businesses decide how often they create cash flow statements depending on the number of transactions they have. For some companies with a lot of cash movement, a weekly or monthly statement is warranted; for others, quarterly or yearly works just as well.
What Are Some Examples of Financing Activities?
Examples of cash flows from financing include cash from the issuance of notes or bonds payable, cash proceeds from the issuance of capital stock, and cash payments for dividend distributions. A business reports money received from short-term loans and long-term loans as cash inflows. It also records cash inflow when it gains cash from issuing bonds or shares of stock.
Cash inflows increase the amount of cash and cash equivalents. On the other hand, activities that reduce the company's cash and cash equivalents include repaying short-term or long-term liabilities, distributing cash dividends to stockholders, and redemption of previously issued bonds payable.
Below are definitions and examples of the accounts that are increased or decreased by a company's financing activities.
Liabilities
A company's financing activities affect the amount of short-term or long-term liabilities they report on the balance sheet. A short-term liability refers to financial obligations that need to be paid within one year, and they're listed in the current liabilities section of the balance sheet.
Short-term liabilities related to financing activities include dividends payable, short-term loans, and the current payable portion of long-term liabilities. Note that short-term liabilities and the current portion of long-term debt are listed separately in the balance sheet. This is done to provide an accurate picture of a company's liquidity and its ability to pay current obligations as they come due.
Long-term liabilities refer to financial obligations that are not due within 12 months or the company's operating cycle, whichever is longer. Long-term liabilities are also called long-term debts or noncurrent liabilities. Examples of long-term obligations related to financing activities are bonds payable, long-term notes payable, and mortgage payable.
Businesses take on long-term debts to obtain funds to invest in new projects or buy capital assets, such as buildings or land. A company's ability to pay its long-term liabilities represents its long-term solvency.
Stockholders' Equity
Stockholders' equity refers to the book value of a company. It's calculated by deducting the total liabilities from the total assets. A company's balance sheet reports stockholders' or owners' equity.
Initially, a company's equity comes from capital invested by the owners. Capital can also be obtained through share offerings when a company sells preferred or common stocks in the market. Over time, equity comes from the business's retained profits through day-to-day operations.
A negative owners' equity means the company owes more money than it owns. It could be an indication of impending bankruptcy unless the business gets an infusion of cash.
Cash Inflows
A company raises capital by issuing debt or equity. Issuing debt or borrowing doesn't affect a company's ownership because it doesn't grant proprietary interest to creditors. The issuance of debt is a cash inflow. Examples of these financing activities include the sale of treasury stock, issuing bonds, and getting a line of credit or a loan from a financial institution.
Another way a business raises capital to finance its operations involves giving up some ownership stake in the company in exchange for funding. Issuance of equity gives the company additional cash, so it's a cash inflow.
Cash Outflows
When a business issues debt or equity for cash, it gains capital to fund expansion or other projects. However, debt and equity have to be repaid at some point. These repayment activities result in cash outflows for the company. Interest payments for repayment of debts are cash outlays, but they're not considered financing activities. They're recorded in a separate section — the operating activities — of the cash flow statement.
Repayment of existing loans, the redemption of bonds, and the purchase of treasury stocks are all outflows related to paying off borrowed funds. For issued equity, earnings are shared with equity holders or stockholders through cash dividend payments. Now and then, a company might also decide to repurchase previously issued shares of stock. These are all financing activities that create cash outflows for the company.
Are Bank Loans a Financing Activity?
Yes, borrowing money on a short-term or long-term basis from the bank is considered a financing activity. However, the debt must be used to acquire capital or funding for a company and not for the business owner's personal use. The resulting cash inflow is reported in the company's statement of cash flow under the financing activities section.
Is Issuance of Bonds a Financing Activity?
Yes, the issuance of bonds by a company is a financing activity. Financing activities are cash flows between a business, its owners, and its creditors. Issuing bonds is a cash exchange between a company and a creditor.
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The financing activities of a business give an overview of its financial health and future plans. An increase in the cash flow from financing activities shows the company's attractiveness to both investors and creditors. More cash inflows than outflows also mean an increase in assets or equity.
Managing operations activities, financial investments, and financing activities are all part of cash flow management. Cash flow management is essential for every business. A company needs to manage its cash well to have money for expenses and expansion and to repay creditors and investors.
Keep track of the cash inflows and outflows from your financing activities with Skynova's accounting software. Use the software to generate financial documents like balance sheets, income statements, and cash flow statements. A balance sheet shows your company's equity standing, while a cash flow statement helps you identify whether your business has enough cash to pay for upcoming short-term and long-term expenses.
Explore our platform for other software products and business templates that can help you manage your business's finances.
Notice to the Reader
The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always consult with a professional for specific and individual accounting advice.