BALANCECHEAT / FIELD NOTES
How the three financial statements connect
Performance, position and cash movement are three views of the same business. The links between them are what make a financial model work.
One business, three views
The Income Statement measures revenue, expenses and profit over a period. The Balance Sheet records assets, liabilities and equity at a point in time. The Cash Flow Statement reconciles opening and closing cash through operating, investing and financing activities.
The essential links
- Net income increases equity through retained earnings; dividends reduce it.
- Non-cash depreciation reduces profit and PP&E, then is added back in indirect operating cash flow.
- Changes in receivables, inventory and payables reconcile profit to cash.
- Capex increases PP&E and reduces investing cash flow.
- Debt issuance increases debt and financing cash flow; repayment reverses both.
- Ending cash in the Cash Flow Statement appears on the Balance Sheet.
A worked credit sale
Sell €1,000 of services on credit with no additional costs, taxes or distributions in this isolated example. Revenue and net income rise €1,000. Receivables and equity both rise €1,000. In indirect CFO, the €1,000 profit is offset by the €1,000 increase in receivables. Cash does not change.
When the customer pays, receivables fall €1,000 and cash rises €1,000. CFO increases by €1,000 at collection; no new revenue is recorded. Total assets are unchanged by the collection.
Direct versus indirect cash flow
The direct method groups operating receipts and payments. The indirect method starts from net income and reconciles non-cash expenses and working-capital timing. Both arrive at the same operating cash flow. Classification choices can differ across reporting frameworks; this educational model classifies cash interest and taxes as operating.
Two checks that must always hold
Opening cash + change in cash = ending cash
If either check fails, investigate the transaction mapping rather than inserting an unexplained balancing figure. A balanced model can still be economically unrealistic, so also check cash needs, margin assumptions and capital intensity.
Use the calculator below to change the amount collected on a simplified credit sale, then explore the full model with working capital, investment and cash flow, and returns on capital.