To understand a company's financial statements, you first need to understand the three main activities of a company. These are operating activities, investing activities, and financing activities. In this lecture, we will explore what each activity means and how they are interconnected.
The most important of these activities is undoubtedly operating activities. What is the ultimate goal of a company? Simply put, it is to make money. While a company can make money through investing activities, it typically generates revenue through operating activities. Operating activities refer to the day-to-day activities a company engages in to generate sales and manage costs. Examples of operating activities include selling goods or services, purchasing inventory, manufacturing products, and paying salaries or rent. These are all representative examples of operating activities.
Next is investing activities. Investing activities refer to the actions a company takes to buy or sell assets in order to grow or maintain its operations. Typically, companies purchase assets for future growth. Common examples of investing activities include capital expenditures (CapEx), research and development (R&D), and mergers and acquisitions (M&A). One point to clarify is that if a company makes an investment and then sells it to recover cash, that is also considered an investing activity. This is often confused with financing activities, so I want to emphasize this distinction.
Finally, there are financing activities. Financing activities are related to the process of raising capital for the company or returning funds to stakeholders. In other words, financing activities refer to how a company obtains the funds necessary for its operations or investments. This includes a range of activities such as borrowing money from a bank, issuing bonds or stocks, paying interest, and distributing dividends.
Then, how do these three activities generally interact with each other? It’s usually best to think about financial activities first. To start a business, you would borrow money or make an investment to secure cash. Then, with that money, the manager would use it for operations or investment activities. And through investment activities, for example, if a machine is purchased, that machine will be used for operations. In the end, the purpose of both financial activities and investment activities is to help operations succeed. When this happens, the business can make money through operations. Once money is made, there are many things that can be done with it. It can be used again for operations, for additional investments, or for financial activities, such as paying back the money borrowed from the bank.
Thus, the three main activities of a company interact with each other, and when this cycle operates smoothly, the company can grow well. However, if even one part of this cycle fails, the company could face a very difficult situation. For example, it’s a common scenario in movies or dramas, but if a company fails to borrow money, it will immediately be unable to make investments for the future, and as a result, its operations will deteriorate. Naturally, instead of growth, it could become a very risky situation. You might be wondering how all of this relates to accounting, and we will continue this discussion in the next session.
