Read the following information and answer the question.

Kavita is the C.E.O of ABC Ltd. Which deals in the manufacturing of toys. It earned ₹2,00,000 net profit for the year 2021-22. They transferred ₹20,000 to General Reserve. Kavita is concerned about the Cash Position of the company. She enquired with the different departments of the company about their cash positions. It was acknowledged that the company has received ₹85,000 cash from its manufacturing activities. There was a sale of an old machine for ₹1,00,000 (Book Value ₹1,20,000). The Preference shares were redeemed for ₹2,00,000. Interest Received on Investment and Interest paid on Debentures were ₹10,000 and ₹20,000 respectively.

In which type of activity, the cash flow from manufacturing activity deal?

Operating activity

The correct answer is option 1- Operating activity. 

Manufacturing Activities are the Operating Activities of the firm. Operating activities are the activities that constitute the primary or main activities of an enterprise. For example, for a company manufacturing garments, operating activities are procurement of raw materials, incurrence of manufacturing expenses, sale of garments, etc. These are the principal revenue-generating activities (or the main activities) of the enterprise and these activities are not investing or financing activities.

OTHER OPTIONS

• Investing Activities- As per AS-3, investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Investing activities relate to purchase and sale of long-term assets or fixed assets such as machinery, furniture, land and building, etc. Transactions related to long-term investment are also investing activities. Separate disclosure of cash flows from investing activities is important because they represent the extent to which expenditures have been made for resources intended to generate future income and cash flows.

• Financing Activities- Financing activities relate to long-term funds or capital of an enterprise, e.g., cash proceeds from the issue of equity shares, debentures, raising long-term bank loans, repayment of bank loan, etc. As per AS-3, financing activities are activities that result in changes in the size and composition of the owners’ capital (including preference share capital in case of a company) and borrowings of the enterprise. Separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of funds (both capital and borrowings) to the enterprise.

• Cash Equivalents- According to Accounting Standard 3 (AS-3), 'Cash' encompasses physical cash on hand and demand deposits held in banks. 'Cash equivalents' refer to short-term, highly liquid investments that can be quickly converted into known amounts of cash with minimal risk of value fluctuations. Typically, an investment qualifies as a cash equivalent when it has a short maturity period, often three months or less from the acquisition date. Investments in stocks are not considered cash equivalents unless they meet specific criteria. For instance, preference shares that are acquired shortly before their scheduled redemption date, provided there's minimal risk of the company failing to repay the amount upon maturity, can be treated as cash equivalents. Similarly, short-term marketable securities that can be readily converted into cash without significant changes in their value are also considered cash equivalents. These investments must be highly liquid and easily convertible into cash.