Classification of Cash Flows: Operating, Investing, and Financing Activities
A cash flow statement is a crucial financial report that tracks all cash inflows and outflows of a business during a specific period. Mastering the topic of cash flow statements is essential for Commerce students as it is widely tested in school board exams, professional courses, and competitive exams. A deep understanding of this topic helps in daily business decision-making and financial analysis.
| Activity Type | Description | Common Examples |
|---|---|---|
| Operating Activities | Main revenue-generating activities of the business | Cash from sales, payments to suppliers, salaries paid |
| Investing Activities | Buying or selling long-term assets and investments | Purchase of machinery, sale of investments, buying land |
| Financing Activities | Raising or repaying funds for business operation | Issuing shares, repaying loans, paying dividends |
Cash Flow Statement: Concept and Importance
The cash flow statement summarizes how cash moves within a business under three sections: operating, investing, and financing activities. This statement helps assess a company’s liquidity, financial health, and ability to generate cash for future needs. It is especially important for exam preparation as questions often test classification, calculation, and understanding of each activity's impact on a business.
MCQs on Cash Flow Statements with Answers
Below are practical MCQs to help students practice real exam questions. Each question covers key concepts related to the cash flow statement for Commerce exams.
-
Which of the following activities is NOT an investing activity in a cash flow statement?
- (A) Sale of machinery
- (B) Purchase of shares
- (C) Payment of salary
- (D) Purchase of equipment
Explanation: Payment of salary is an operating activity, not investing. -
Cash Flow Statement is prepared to show:
- (A) Profitability
- (B) Movement of cash
- (C) Financial position
- (D) Changes in working capital
Explanation: The main purpose is to track cash inflows and outflows during a period. -
Depreciation is:
- (A) Cash outflow
- (B) Cash inflow
- (C) Non-cash expense
- (D) Investing outflow
Explanation: Depreciation impacts profit but does not result in a cash movement. -
Issue of shares is classified under which section of the cash flow statement?
- (A) Operating
- (B) Investing
- (C) Financing
- (D) Cash Equivalents
Explanation: Issuing shares is a financing activity as it raises capital. -
Which of the following is considered a cash equivalent?
- (A) Debtors
- (B) 3-month fixed deposit
- (C) Machinery
- (D) Prepaid rent
Explanation: Short-term deposits (up to 3 months) are treated as cash equivalents. -
Dividends paid are shown under:
- (A) Operating activities
- (B) Investing activities
- (C) Financing activities
- (D) None of the above
Explanation: Dividends paid reduce financing as they are cash outflows to shareholders. -
Repayment of bank loan is:
- (A) Operating activity
- (B) Investing activity
- (C) Financing activity
- (D) Cash equivalent
Explanation: Repayment or raising of loan is always shown in the financing section. -
The term 'cash flows' refers to:
- (A) Only cash receipts
- (B) Only cash payments
- (C) Both cash receipts and payments
- (D) Only non-cash items
-
Sale of old equipment will be shown in the cash flow statement as:
- (A) Operating inflow
- (B) Investing inflow
- (C) Financing inflow
- (D) Not shown at all
Explanation: Sale of fixed assets is an investing activity. -
Cash receipts from customers are classified as:
- (A) Operating activities
- (B) Investing activities
- (C) Financing activities
- (D) All of the above
Stepwise Solution Example
To find cash from operating activities using the indirect method:
- Start with net profit (from the profit and loss account).
- Add back non-cash expenses (like depreciation, amortization).
- Subtract non-operating incomes (like profit on asset sale).
- Adjust for changes in working capital items (add decrease in debtors, subtract increase in stock).
This method helps in reconciling net profit with actual cash generated from core operations—a frequent cash flow statement MCQ area.
Quick Revision Table: Activities and Examples
| Activity | Typical Examples | Possible MCQ |
|---|---|---|
| Operating | Cash sales, payment to suppliers, salary payments | Which activity includes payment of wages? |
| Investing | Purchase/sale of plant, investment in shares, receiving interest | Sale of machinery is what type of activity? |
| Financing | Issuing shares/debentures, borrowing, repayment of loans, dividend paid | Repayment of loan—what activity? |
Applying Cash Flow Statement Knowledge
In real-world business, cash flow statements are used by managers and investors to make strategic decisions. During exams, students must correctly classify activities, identify cash/non-cash transactions, and perform stepwise calculations. At Vedantu, we simplify commerce concepts to help learners master these scenarios for both academic and competitive success. For deeper study, explore related pages such as Difference Between Cash Flow and Fund Flow and Analysis of Financial Statements.
Download MCQs on Cash Flow Statements (PDF)
For easy revision, download a PDF copy of these MCQs with detailed answers. This supports last-minute practice and offline study before important exams.
Download PDF: Cash Flow Statement MCQs with Answers
Summary
A cash flow statement captures all movements of cash in a business, organized by operating, investing, and financing activities. Learning to classify activities, understand cash equivalents, and apply this knowledge is valuable for exams and business use. Practicing MCQs aids quick recall and deeper mastery, making this topic a foundation in Commerce education.
FAQs on MCQs on Cash Flow Statements with Answers and Explanations
1. What is a cash flow statement?
A cash flow statement summarizes a company's cash inflows and outflows from operating, investing, and financing activities over a period. It's crucial for understanding a business's liquidity and financial health.
2. What are the three main activities in a cash flow statement MCQ?
The three main activities are operating activities (day-to-day business), investing activities (long-term assets), and financing activities (funding sources).
3. Which of the following is an operating activity?
Operating activities include cash flows from the main business operations. Examples include cash received from sales, payments for expenses (like salaries and rent), and cash from interest received. Investing and financing activities are separate.
4. Why is the cash flow statement important?
The cash flow statement is vital because it shows how a company generates and uses cash. It helps assess liquidity, solvency, and overall financial health. This is crucial for investors, lenders, and management.
5. What are the components of a cash flow statement?
The statement typically shows cash flows from operating, investing, and financing activities. Each section details cash inflows and outflows related to those activities. For example, operating activities might include cash from sales and payments to suppliers.
6. How do you classify cash flows in MCQs?
Cash flows are classified into operating, investing, and financing activities. Understanding the difference between these activities is key to correctly answering MCQs on cash flow statements. Each type reflects different aspects of a business's financial activity.
7. What is the difference between cash flow and fund flow?
Cash flow focuses solely on cash and cash equivalents. Fund flow is broader, encompassing all changes in working capital, including non-cash items. MCQs might test your understanding of this distinction.
8. Why is depreciation added back to net profit in cash flow statements?
Depreciation is a non-cash expense. It reduces net profit but doesn't involve actual cash outflow. Therefore, it's added back to net profit when calculating cash flow from operating activities.
9. How are cash equivalents tested in MCQs?
MCQs might test your understanding of cash equivalents by asking which short-term, highly liquid assets are considered cash equivalents according to accounting standards. These usually include items like short-term treasury bills.
10. What is included in each activity in a cash flow statement?
Operating activities include cash flows from normal business operations. Investing activities involve cash flows related to long-term assets (e.g., buying equipment). Financing activities relate to how the business raises funds (e.g., issuing shares or borrowing). MCQs may involve scenarios from each.
11. Are dividends paid an investing or financing cash flow?
Dividends paid are classified as a financing activity because they represent a distribution of profits to shareholders, a funding-related transaction.
