CSLB Law & Business ExamBusiness FinancesMedium
A contractor receives $50,000 from a bank loan and uses $20,000 of it to purchase new equipment. On the Statement of Cash Flows, how should these two transactions be classified?
- ABoth are financing activities
- BLoan proceeds are financing; equipment purchase is investing
- CBoth are operating activities
- DLoan proceeds are investing; equipment purchase is financing
Show answer & explanationAnswer & explanation
Correct answer: B. Loan proceeds are financing; equipment purchase is investing
Cash from borrowing is a financing activity because it involves debt or equity funding. Buying equipment is an investing activity because it involves acquiring long-term assets.
Why the other options are wrong
- A. Equipment purchases are investing activities, not financing.
- C. Operating activities relate to day-to-day business income and expenses, not loans or asset purchases.
- D. This reverses the correct classifications for the two transactions.
Statement of Cash Flows Categories
A financial statement dividing cash inflows and outflows into three categories: operating, investing, and financing activities.
- Operating: day-to-day business cash (revenue, expenses, payroll)
- Investing: buying/selling long-term assets like equipment
- Financing: loans, owner contributions, and loan repayments
Memory trick: Operate daily, Invest in stuff, Finance with others' money.