In everyday business operations, monitoring operating cash flows is critical. While income statements show profits, they don’t always reflect the actual cash position. That’s why the operating activities section of the cash flow statement becomes a vital tool.
Operating activities are those business functions that relate directly to revenue generation sales, purchases, payments to employees and suppliers, and other routine expenses. This section gives business owners, CFOs, and accountants a clear view of whether the company is generating enough cash from its regular operations to sustain itself.
What Is Included in Operating Activities?
Operating activities typically include:
- Receipts from customers
- Payments to suppliers
- Salaries and wages
- Rent and utility payments
- Tax payments
- Other overheads directly linked to day-to-day operations
These are the actual cash inflows and outflows that occur during the regular business cycle. Managing these transactions effectively ensures smoother operating cash flows and better control over liquidity.
Methods of Reporting: Direct vs. Indirect
There are two methods to prepare the operating activities section in the cash flow statement:
1. Direct Method (Cash-Based)
This method lists all major operating cash transactions directly. It is straightforward and provides a clear picture of actual cash movements.
Typical Components in Practice:
| Transaction Type | Example Entry |
| Cash received from customers | Based on bank receipts or sales ledger |
| Cash paid to suppliers | Based on payment vouchers or bank payments |
| Salaries paid | Payroll records |
| Rent and utilities | Paid invoices |
| Tax payments | TDS/GST/income tax payments |
In business use:
Companies using real-time cash accounting (e.g., retail, hospitality) prefer this to track daily liquidity positions.
2. Indirect Method (Accrual Adjustments)
This method starts with net profit (from the Profit & Loss Statement) and makes adjustments for:
- Non-cash expenses (e.g., depreciation)
- Non-operating items (e.g., profit/loss from asset sale)
- Changes in working capital (e.g., receivables, payables, inventory)
Practical Adjustments Explained:
| Adjustment | Reason / Example |
| Add: Depreciation/Amortization | Non-cash expenses reducing P&L profit |
| Add: Loss on sale of asset | Reduced profit but no operating cash impact |
| Less: Profit on sale of asset | Boosted profit but not an operating activity |
| Changes in trade receivables | Increase = cash not collected; Decrease = improved collection |
| Changes in inventories | More inventory = cash tied up; Less = cash freed |
| Changes in payables | Higher payables = retained cash; Lower = cash outflow |
| Outstanding/Prepaid expenses | Reflect timing mismatches between accruals and actual cash flows |
Mini Case: Sales Growing, Cash Shrinking?
A trading company shows ₹20 lakhs in profit but has negative ₹5 lakhs cash from operations. On review, it turns out:
- ₹12 lakhs are stuck in receivables (slow collections)
- ₹4 lakhs invested in excess inventory
- Expenses prepaid for next quarter
Even though profit appears healthy, operating cash is tight. Without timely action, the business could struggle to pay vendors or salaries — a real risk masked by accounting profits.
Practical Checklist for Monthly Cash Flow Review
| Checkpoint | Action |
| Have customer payments been received on time? | Compare receivables aging monthly |
| Are supplier payments aligned with credit terms? | Review accounts payable schedule |
| Is inventory turnover in control? | Monitor stock-to-sales ratio |
| Are we carrying too many prepaid expenses? | Reassessed advance payments quarterly |
| Are non-cash charges adjusted correctly in an indirect method? | Confirm with depreciation & amortization schedule |
Final Thoughts
Focusing on operating activities helps businesses maintain a strong grip on day-to-day financial health. Whether using the direct method for cash visibility or the indirect method for accounting compliance, linking cash flow to real transactions builds clarity.
By applying this guide, businesses can improve working capital, make smarter decisions, and stay financially resilient through routine review and discipline.
LinkedIn Link : RMPS Profile
This article is only a knowledge-sharing initiative and is based on the Relevant Provisions as applicable and as per the information existing at the time of the preparation. In no event, RMPS & Co. or the Author or any other persons be liable for any direct and indirect result from this Article or any inadvertent omission of the provisions, update, etc if any.
Published on: April 30, 2025