Financing activities include long-term liabilities transactions, owner’s equity, and changes to short-term borrowings. The activities comprise the cash and cash equivalents flow between the company and its financing sources, i.e., investors and non-trading creditors, such as long-term loans, bonds payable, etc.
The cash flow from financing activities is the funds the company has collected or paid to finance its activities. It’s one of the three sections of a company’s cash flow statement, while the two other sections are operating and investing.
What this article covers:
- What Are Financing Activities in Cash Flow Statement?
- What is Included in Financing Activities Examples?
- Why is Cash Flow from Financing Important?
What Are Financing Activities in Cash Flow Statement?
In the cash flow statement, financing activities refer to the flow of cash between a business and its owners and creditors. It focuses on how the business raises capital and pays back its investors. The activities include issuing and selling stock, paying cash dividends, and adding loans.
A positive number on the cash flow statement indicates that the business has received cash. This boosts its asset levels. On the other hand, a negative figure indicates the business has paid out capital, such as making a dividend payment to shareholders or paying off long-term debt.
What is Included in Financing Activities Examples?
Inflows — Raising Capital
- Equity Financing: This corresponds to selling your equity to raise capital. Here the money is raised without any obligation to pay any principal or interest but at the cost of ownership. It’s an inflow which at the face of it looks easy money but in the long term may prove very costly. As sometimes, you might end up paying more interest because of a growing business than the prevailing market rates.
- Debt Financing: Another way of raising capital can be issuing long-term debt such as bonds. This, in contrast to equity financing, does not dilute ownership but makes the firm liable to pay fixed interest and return the money within the promised timeframe, generally for 10 or 20 years.
- If the firm is a not-for-profit organization, then donor contributions can also be part of the financing.
Outflows — Return Capital
- Repayment of Equity: When owners have got enough wealth in-store, they would like to buy back the company stock and once again increase their ownership. They can do so through multiple ways like – buying stocks from an open market, bringing an offer for sale, or proposing a buyback.
- Repayment of Debt: Like any fixed deposit, firms must repay the debt after a definite period as promised at the time of the issue.
- Dividend Payment: This is a mechanism by which firms reward their shareholders and share their profit. Since these are subject to tax, firms sometimes use the capital to buy back shares from the shareholders by bringing a buyback offer. This decreases the number of shares in the market and hence increases the earnings per share.
Why is Cash Flow from Financing Important?
Cash flow from financing tells you whether the company is raising or returning capital. Typically, a company in the early stage of its life will show a positive cash flow from financing as it raises capital to grow. When a company is mature (the industry growth has slowed), we would expect to see negative cash flow from financing as the company can start to repatriate capital either by repaying debt, repurchasing equity, or paying dividends.