Having known the roles and functionality of individual financial statements, it is also important to understand how the three financial statements are interlinked.
There are a few “keys” that link the different financial statement with one another:
Income statement to cashflow statement: “net income” is the key that links the income statement with cashflow statement. The cashflow statement starts with net income (ie. bottom line from income statement), adjusts for non-cash items (eg. depreciation, amortization, working capital changes, etc.) to arrive at operating cashflow.
Cashflow statement to balance sheet: “ending cash” is the key that links the cashflow statement with balance sheet. As mentioned, cashflow statement starts with net income, adjusts for non-cash items, takes into account capex, investments, etc. to arrive at cash at the end of a financial period (ie. “ending cash”.) This ending cash goes into the balance sheet under current asset; in order words, we can understand the cash item as a plug that balances assets with liabilities and equities.
Income statement to balance sheet: “retained earnings’ is the key that links income statement with balance sheet. Retained earning represents the portion of net income that does not get distributed in dividend; in other words, retained earnings (from income statement) is added to equity (on balance sheet), thereby increasing the entitlement of the company’s shareholders.
Source: Tutors Globe
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