Which of the following is the most likely classification for a clothing manufacturer borrowing funds to purchase raw material?
Operating activity
Investing activity
Financing activity
Answer: C
Borrowing of funds is not part of the day-to-day activities for a clothing manufacturer. Hence, it is classified as a financing activity.
Was thinking Investing. I thought financing activities are thse that change the capital structure ie issuance of debt and common stock. Can anyone explain to me why its Financing instead of Investing actiities?
This refers to taking on addditional external debt (whether through a loan or emission of debt obligations is not specified here) in order to purchase raw material. This does indeed change the existing capital structure towards more leverage and is a typical financing inflow.
There is no investing cash-flow involved at all in this transaction.
It’s not operating for sure. It ain’t investing either as it’s not an investment nor does it give any rise to NCA. It does increase NCL so the capital structure changes.
But, why would firm use Long term debt to finance working capital or current asset?