Meaning

Financing activities are transactions that companies undertake to help achieve their economic goals and objectives.

It involving activities that affects business’ long-term liabilities, owner’s equity and changes to short-term borrowings. These activities involve the flow of cash and cash equivalents between the company and its sources of finance i.e. the investors and creditors for non-trading liabilities such as long-term loans, bonds payable etc.

{Anything to do with the movement of money, i.e. cash inflows and outflows, is a financial activity.}

For example, purchasing and selling of products or assets, organizing and maintaining accounts, arranging loans, selling stocks or bonds, etc are recorded as financial activities. Both cash inflows and outflows from creditors and investors are considered in financing activities.

Financing activities shows how a company uses its funds in operations and expansions externally.

{Note: Internal financing is not included as financing activity. For example, if a company pays for its own plant expansion it doesn’t need financing. Thus, in such circumstances no financing activities is recorded because equity and liability accounts are unchanged by the expansion.}

Why Financing Activities is Important?

Financing activities reveal the characteristics of the funding structure of a company. It showcases how a business bring and maintain its funds for its future operations.

Both creditors and investors are interested to see how efficiently a business uses its existing cash to fund operations and how effectively it raises capital for upcoming events. In a way, the financing activities section in the cash flow statement indicates how liquid a company is.

What is Included in Financing Activities?

(A) Cash Inflow – Raising Capital

1) Equity Financing:

This includes selling your equity to raise capital. In this, funds is raised without any obligation to pay any principal amount or interest but at the cost of ownership. It’s an inflow of cash which at the time looks easy money but in the long term may prove very costly.

2. Debt Financing:

Another way of raising funds is by issuing long term debt such as bonds. This, unlike equity financing, Debt Financing dilute ownership but makes the company liable to pay fixed interest and return the money within the period of time normally for 10 or 20 years.

3. Donor contributions:

If a company is a not for profit organization (NGO), then donor contributions can also be part of the financing activities.

(B) Cash Outflow – Return Capital

1. Repayment of Equity:

 When owners have enough wealth in bank, they sometimes try to buyback the company shares to increase their ownership in a company. It can be done through multiple ways like – buying shares from an open market, bringing offer for sale, or proposing a buyback.

2. Repayment of Loan:

Like any fixed deposit, companies must repay the loan after a certain period as promised in a written contract at the time of the issue.

3. Dividend Payment:

It is an activity by which a company reward its shareholders by sharing some part of their profit with them. Since it is subjected to tax, a company sometimes uses its capital to buy back the shares from the shareholders by bringing a buyback offer. This in-turn decreases the number of shares in the market and hence increases the earnings per share.

Examples of Financing Activities

Some examples of cash flows from financing activities are:

Positive Cash flow:

• Issuing bonds
• Cash from new stock issued
• Sale of treasury stock
• Loan from a financial institution

Negative Cash flow:

• Payment of cash dividend to stockholders
• Repayment of existing loans
• Redemption of bonds
• Purchase of treasury stock
• Repurchase of existing stock

The financing activities of a business gives an insights of a company’s financial health and its upcoming goals. These activities may or may not involve the use of cash. However, only those activities that affect cash are reported in the cash flow statement.

Whereas, the activities that don’t have an impact on cash are called non-cash financing activities. These include the conversion of debt to common stock or discharging of a liability by the issuance of a bond payable.

A positive cash flows from financing activities may show the business’ intentions of growth and expansion. With more cash is coming in than going out, a positive amount indicates an increase in business assets and financial health.

Negative cash flows from financing activities, on the other hand, can signal improving liquidity position of the business and also provide information about its dividend policy.

Reference

• https://www.investopedia.com/terms/c/cashflowfromfinancing.asp
• https://www.freshbooks.com/hub/accounting/financing-activities
• https://marketbusinessnews.com/financial-glossary/financial-activities/
• https://www.myaccountingcourse.com/accounting-dictionary/financing-activities
• https://corporatefinanceinstitute.com/resources/knowledge/accounting/cash-flow-from-financing-activities/
• https://enterslice.com/learning/financing-activities-importance-of-financing-activities-for-business/
• https://www.accountingcoach.com/blog/financing-activities-cash-flow-statement-2
• https://www.wallstreetmojo.com/financing-activities/