The relationship between financial statements

The financial statements are comprised of the income statement, balance sheet, and statement of cash flows. These three statements are interrelated in several ways, as noted in the following bullet points:

  • The net income figure in the income statement is added to the retained earnings line item in the balance sheet, which alters the amount of equity listed on the balance sheet.
  • The net income figure also appears as a line item in the cash flows from operations section of the statement of cash flows.
  • Changes in various line items in the balance sheet roll forward into the cash flow line items listed on the statement of cash flows. For example, an increase in the outstanding amount of a loan appears in both the liabilities section of the balance sheet (as an ongoing balance) and in the cash flows from financing section of the statement of cash flows (in the amount of the incremental change).
  • The ending cash balance in the balance sheet also appears in the statement of cash flows.
  • The purchase, sale, or other disposition of assets appears on both the balance sheet (as an asset reduction) and the income statement (as a gain or loss, if any).

In short, the financial statements are highly interrelated. Consequently, when reviewing the financial statements of an organization, one should examine all of the financial statements in order to obtain a complete picture of its financial situation.