Subject 1. The Classification of Business Activities

Business activities can be classified into three groups:

  • Operating activities involve those activities conducted in the course of running a business. These activities determine net income and changes in the working capital account (accounts receivable, inventory, and accounts payable). Examples:

    • Selling goods and services
    • Employing managers and workers
    • Buying goods and services
    • Paying taxes

  • Investing activities are those associated with spending funds to begin and continue operations. In general, these activities affect the long-term asset items on the balance sheet. Examples:

    • Buying resources such as land, buildings, and equipment needed in the operation of the business.
    • Selling these resources when no longer needed.

    Selling land, buildings, and equipment is associated with investing activities, even though it results in a cash inflow, because it involves resources used to begin and continue operations.

  • Financing activities are related to obtaining or repaying capital. In general, these activities affect the debt and the equity items on the balance sheet. Examples:

    • Issuing stock
    • Paying dividends to stockholders
    • Obtaining loans from creditors
    • Repaying amounts plus interest to creditors

    Payments of dividends and interest are associated with financing activities, even though they involve cash outflows, because they are necessary to obtain funding.

In Reading 26 [Understanding the Cash Flow Statement] a more detailed discussion of different business activities and their impact on cash flows will be provided.

Practice Question 1

Which of the following is not an operating activity?

A. Employing managers
B. Purchasing services
C. Paying taxes to the government
Correct Answer: None of these

Employing managers, purchasing services, and paying taxes to the government are all operating activities. Operating activities include business activities undertaken in the course of running a business and affect net income.

Practice Question 2

Which of the following is not a financing activity?

A. Purchasing a building
B. Obtaining a loan/paying off a loan
C. Issuing stock
Correct Answer: A

Purchasing a building is an investing activity. Investing activities involve using capital in productive ways that will help a business achieve its objectives. Financing activities are those that involve obtaining resources from investors and creditors and providing a return on investments or loans in the form of dividends or interest, such as obtaining a loan, issuing stock, and paying off a loan.

Practice Question 3

Which of the following is an investing activity?

A. Issuing stock/paying dividends
B. Paying taxes
C. Selling land
Correct Answer: C

Investing activities involve using capital in productive ways that will help a business achieve its objectives. Selling land is an investing activity. Paying taxes is an operating activity. Operating activities include business activities undertaken in the course of running a business and affect net income.

Practice Question 4

The purchase of equipment is an example of a(n) ______ activity.

A. investing
B. financing
C. operating
Correct Answer: A

A. The purchase of equipment is an investing activity. Investing activities include buying resources that are needed in the operation of a business and selling those resources when they are no longer needed.

B. Obtaining a loan from a creditor is an example of a financing activity. Financing activities are used to obtain adequate funds, or capital, to begin and to continue operating a business.

C. Selling goods to a customer is an example of an operating activity. Operating activities are business activities undertaken by management in the course of running a business.