What Are Financing Activities?
Definition: Financing activities are operations through which a business or company raises capital to finance operations. Simply put, they are transactions that affect long-term liabilities as well as equity of firms. The transactions involve creditors or investors that invest requested amount of money
Above all, financing activities show how businesses raise funds to finance operations and expansions. Similarly, financing activities include cash flows and outflow. However, internal financing is never included as part of financing activities.
Cash flow, as part of financing activities, may include investment from creditors in the form of new loans. Cash outflow, on the other hand, may entail cash payments made by a business to cater to loan and interest payments.
Investors also play a pivotal role when it comes to financing activities. Public companies often issue stock to the public and, in return, generate additional capital on investors buying the stock. Likewise, public companies also make dividend payments and owner distributions to investors, which amount to cash outflows.
Financing Activities on the Cash Flow Statement
Financing activities is one of the main sections in the statement of cash flows, with the other two being operating and investing activities. Only financing activities that involve cash are included in the statement of cash flow. Activities that don’t include cash, often referred to as non-cash financing are never included. The non-cash activities may include the conversion of debt to common stock or the issuance of a payable bond.
When listed in the statement of cash flow, financing activities denote the flow of cash between the business and creditors or investors. In the statement of cash flows, financing activities are listed as either:
- The borrowing and repaying of short term loans
- Borrowing and repaying of long term liabilities
- Issuance and the reacquisition of shares of common stock
- Payments of cash dividends.
A positive number on the statement of cash flow indicates the surplus and ability of a company to borrow and repay. Likewise, a positive statement of cash flow goes a long way in boosting the asset value of a business. A negative figure, on the other hand, may indicate that a business has settled out all its debt and made dividend payments
The source of capital is one of the key components included in the statement of cash flow. In this case, the source of financing activity can be either equity or debt. In this case, debt can be in the form of a loan from a bank or other financial institution or the issuance of a bond. The equity route, on the other hand, may include the issuance of stocks to investors who purchase a stake in the company.
Advantages of Financing Activities
Financing activities provide an avenue for businesses and companies to raise additional capital for supporting growth and expansion opportunities. The ability to raise additional capital can cause a company to lose on a lucrative business opportunities as well as customers.
Financing activities also provide valuable insight into the financial health of a firm. Buyback activities, for instance, affirm a company’s growth story.
Financing Activities Disadvantages
Financing activities tend to attract increased regulatory scrutiny. Regulators tend to pay scrutiny to how firms raise money and how the same is utilized. A slight mistake would most of the time trigger legal hassles.
Financing activities can plunge a firm into financial problems, especially when interest payments are much more than what the firm borrowed.
The issuance of stock to raise capital as part of financing activity can dilute stock holdings significantly.
Summary
Financing activities are important components in statements of cash flow. Likewise, such activities provide insights onto a business financial health and goals. A positive cash flow affirms a solid financial position capable of supporting expansion as well as business growth. Negative cash flow as a result of financing activities, may indicate improving liquidity in addition to providing information to a company’s dividend policy.