Understanding Business Activities: The Key to Managerial Accounting

Ever wondered what makes a business run? It boils down to three main activities: financing, investing, and operating. These activities drive every company, and they are essential for understanding financial statements, as they reflect how resources are generated and used within a company.

Accounting systems keep track of all three types of activities in general, and this kind of information is the subject of managerial accounting. This discipline involves the use of financial information to help managers make informed business decisions.

Planning represents another crucial business function, though experts don't typically categorize it alongside the three principal activities. Planning comes before all other business operations. Management teams establish company objectives and develop strategies to reach these goals during the planning process.

In this blog post, we will explore each activity, see how they connect, and learn why they matter. Let’s keep it simple and dive right in!

Financing Activities: Getting the Money

Every business needs cash to start and grow. Financing activities show how companies get that cash. There are two big ways: borrowing money or selling shares.

Borrowing Money (Debt Financing): Companies can get loans from banks or sell bonds to investors. Bonds are like IOUs that promise repayment later with interest. This borrowed cash creates liabilities - money the business owes. For example, a note payable is a promise to pay back a bank loan later. Bonds payable go to investors and often take years to repay. Creditors (the lenders) get paid first if the company hits trouble.
Selling Shares (Equity Financing): Businesses can also sell stock. This means trading a piece of the company for cash. Shareholders who buy stock don’t expect repayment, but they might get dividends when the company earns profits. If things go wrong, shareholders wait behind creditors to claim anything left.

Most business founders likely use savings and loans to kick things off. That is financing at work - getting the cash to make things happen. Why does this matter? Financing gives businesses the fuel to start and expand. Without it, there is no money for the next steps.

Investing Activities: Using the Money

Once a business has cash, it spends it on resources. These investing activities buy the tools a company needs to operate. We call these resources assets because they help the business grow.

Here are some common assets:

Property, Plant, and Equipment: Think buildings, machines, or delivery trucks. for example, a sportswear company might buy sewing equipment and trucks to make and move clothes.
Inventory: Goods ready to sell, like jackets or boots sitting in a warehouse.
Accounts Receivable: Money customers owe for items they bought but haven’t paid for yet.
Investments: Extra cash might go into stocks or bonds of other companies.

Investing is key. Without assets, a business can’t produce or sell anything. Columbia needed sewing machines before it could stitch a single jacket. The right investments set the stage for success.

Operating Activities: Making Money

Now the business gets to work. Operating activities cover the daily grind - making products, selling them, and serving customers. This is where the money starts rolling in (or out).

Revenues: Cash earned from sales. For example, as with the mentioned sportswear company, this means money from selling snow boots or rain gear. Revenue also includes extras like interest from investments.
Expenses: Costs to keep things running. These vary:
- Cost of Goods Sold: Materials like wool or rubber for boots.
- Selling Expenses: Salaries for salespeople or ad costs.
- Administrative Expenses: Office bills, like rent or executive pay.
- Interest Expense: Costs of borrowed money.
- Income Taxes: Money paid to the government.

When revenues beat expenses, the business earns net income - a profit! If expenses win, it is a net loss. Operating income (revenue minus operating expenses) shows how well the core business performs.

Every sale brings revenue, but every cost, from salaries to shipping, cuts into it. This activity decides if the business thrives. Regular monitoring of operating activities helps in identifying inefficiencies and areas for cost reduction.

Planning: The Strategy Behind It All

Before anything happens, businesses plan. Planning activities set goals and map out how to reach them. It’s the brain behind the action.

Companies plan by:

Checking what customers want.
Watching competitors.
Deciding how much to spend on new products or ads.
Picking the best financing mix.

A solid business plan guides financing, investing, and operating decisions. It’s like a roadmap for success.

The Accounting Equation: Connecting the Dots

These activities tie together with the accounting equation:

Assets = Liabilities + Equity.

Assets: Stuff the business owns, thanks to investing.

Liabilities: Debts from borrowing in financing.

Equity: Owners’ stake, from selling shares and keeping profits.

If a company has $100,000 in assets, $60,000 in liabilities, and $40,000 in equity, the equation balances as $100,000 = $60,000 + $40,000.

This equation always balances. It tracks every move a business makes. If a company buys a truck (asset), it either borrows (liability) or uses owner funds (equity). Simple, but powerful.

Cash Flow vs. Profits

Profits are great on paper, but cash flow rules. Cash flow is the real money moving in and out. A business might have big revenues but still struggle if cash doesn’t arrive fast enough to pay bills. The cash flow statement shows how financing, investing, and operating affect cash. It’s the lifeblood of any company.

Financial Statements: The Big Picture

The three main activities show up in any company's financial statements:

Balance Sheet: Lists assets, liabilities, and equity at one moment.
Income Statement: Tracks revenues and expenses over time, showing net income.
Cash Flow Statement: Follows cash in and out from all three activities.

These reports tell the story of a business. They help to see what is working. Investors rely on the balance sheet to assess financial stability, while managers use the income statement to gauge profitability.

Why Does Managerial Accounting Use Business Activities?

Managerial accounting uses these activities to help run the show. Here is how:

Pricing Products: Knowing the cost of goods sold sets smart prices.
Planning Growth: Cash flow from financing and investing shows what is possible.
Cutting Costs: Spotting high operating expenses saves money.

Managers rely on these numbers to make decisions. For example, cash flow insights guide new store openings. It’s all about running a tighter ship.

Wrapping It Up

Financing, investing, and operating activities power every business. Financing gets the cash. Investing turns it into tools. Operating makes the profits. Planning keeps it all on track. Together, they build any company.

For managerial accounting, these activities are the main sources of information. They provide the data to price products, plan expansions, and boost efficiency. Next time you buy a jacket or a pill, think about the activities behind it. They are what make businesses tick and grow.