Key Difference – Investing vs Financing Activities
Investing activities and financing activities consist of main two sections in the cash flow statement where the cash inflow and cash outflow from the above activities are recorded. The key difference between investing and financing activities is that investing activities record the cash inflow and outflow that result in gains and losses from investments whereas financing activities record the cash inflows and outflows that result in a change in capital structure of the company by raising new capital and repaying investors. Both these items directly affect the overall net cash position since they represent a major portion of cash amount available in the organization.
CONTENTS
1. Overview and Key Difference
2. What are Investing Activities
3. What are Financing Activities
4. Side by Side Comparison – Investing vs Financing Activities
5. Summary
What are Investing Activities?
Investing activities record the cash inflow and outflows that result in gains and losses from investments. The following items result in a cash outflow or an inflow.
Purchase of Fixed Assets
Here the purchase price incurred is regarded as all the expenses incurred to bring the asset into working condition to generate economic benefit. Thus, this does include costs such as delivery and installation in addition to the purchase price.
Purchase of Long Term Investments
Investments generating value for more than one accounting year is included in this category. Stocks, bonds and investment in real estate are some examples for long term investments.
Sale of Fixed Assets
These are the proceeds obtained from disposing off a fixed asset.
Sale of Long Term Investment
These are the proceeds obtained from disposing off a long term investment
Cash flow from investing activities amounts to a major cash flow since fixed assets and long term investments are high in value. Thus, this is particularly important in capital intensive industries, such as manufacturing that require large investments in fixed assets.
What are Financing Activities?
Financing activities record the cash inflows and outflows that result in a change in capital structure of the company by raising new capital and repaying investors. Cash flow from financing activities shows investors the company’s financial strength.
Cash Dividends Paid
Cash dividend is the share of profits paid to shareholders for their investment. Many companies pay dividends annually while some also pay an interim dividend.
Repayment of Borrowing
Repayment is referred to as making periodic payments for borrowed funds from lenders. Such periodic payments usually include a portion of principal and interest.
Share Repurchase
If the company believes that the issued shares of the company is undervalued in the market, then the company can buy back shares. This is done in order to send a signal to the market that the company shares are more valuable than the current trading price.
Obtaining Borrowing
At times when companies face liquidity issues, borrowings can be made to obtain more finance.
Issue of Shares
New shares can be issued to new investors and existing investors when the company wishes to raise new capital. Shares can be issued to both individuals and corporate bodies.
Figure 01: Format of cash flow statement
What is the difference between Investing and Financing Activities?
Investing vs Financing Activities |
|
| Investing activities record the cash inflow and outflows that result in gains and losses from investments | Financing activities record the cash inflows and outflows that result in a change in capital structure of the company by way raising new capital and repaying investors. |
| Components | |
| Purchase and sale of fixed assets and long term investments are important components in investing activities. | Issue of shares, obtaining and repayment of borrowing are major elements in financing activities. |
| Frequency of Investment | |
| Cash flow from investing activities are usually experienced once in a few accounting periods, thus the cash position is not subjected to frequent changes. | Cash flow from financing activities is subjected to frequent alterations if there are elements such as repayment of loan. |
Summary – Investing Activities vs Financing Activities
The difference between investing and financing activities can be mainly distinguished through understanding the components included in each category. Investments in capital assets will be shown under investing activities and changes to the capital structure will be included in the financing activities. The cash availability is a vital aspect for the routine survival of the business. Net cash position becomes vital for all types of organizations for planning future operating and investment activities. As such, cash flow from investing and financing activities play a major role for the overall cash availability for an organization.
Reference:
1.”Activities of the Business: Financing, Investing, and Operating – Boundless Open Textbook.” Boundless. Boundless, 26 May 2016. Web. 10 May 2017. <https://www.boundless.com/accounting/textbooks/boundless-accounting-textbook/introduction-to-accounting-1/overview-of-key-elements-of-the-business-19/activities-of-the-business-financing-investing-and-operating-118-5147/>.
2.”Cash flow statements.” Cash flow statements | Students | ACCA Global | ACCA Global. N.p., n.d. Web. 10 May 2017. <http://www.accaglobal.com/lk/en/student/exam-support-resources/fundamentals-exams-study-resources/f3/technical-articles/cashflow-statements.html>.
3.”Classification of Cash Flows:.” Operating, Investing and Financing Activities – Classification of Cash Flows – AccountingExplanation.com. N.p., n.d. Web. 10 May 2017. <http://www.accountingexplanation.com/classification_of_cash_flows.htm>.
Image Courtesy:
1. “11 Statement Cash Flows Trust Funds” By Ladyfwr – Own work (CC BY-SA 3.0) via Commons Wikimedia