Why Are the Three Financial Statements Linked?
Open any company’s financial report and you’ll find three core statements: the Income Statement, the Balance Sheet, and the Cash Flow Statement. Beginners often treat each one in isolation, but the real skill in financial modeling is understanding how the three are linked — change one number in the income statement, and it automatically ripples through the other two.
Throughout this module we’ll use a simple fictional company, “Noor Trading Co.”, as our running example.
Each statement in one sentence
- Income Statement: answers “how much did the company earn or lose over the period?” — from revenue down to net income.
- Balance Sheet: answers “what does the company own and owe at a specific point in time?” — assets must always equal liabilities plus equity.
- Cash Flow Statement: answers “where did the actual cash go?” — because accounting net income isn’t the same as real cash.
How are they linked?
- Net income from the income statement is the starting point of the cash flow statement, and it also increases retained earnings on the balance sheet.
- Depreciation is deducted as an expense on the income statement, but it’s a non-cash expense, so it’s added back on the cash flow statement — and it reduces net PP&E on the balance sheet.
- Capex shows up as a cash outflow on the cash flow statement, and increases net PP&E on the balance sheet.
- The ending cash balance on the cash flow statement is the same number as “cash” in the balance sheet’s assets.
The end result: if the model is built correctly, the balance sheet must “balance” (assets = liabilities + equity) every single period. If it doesn’t, something in the linkage is wrong.
In the next lesson we’ll break down the income statement line by line, and in the lesson after that we’ll build the full linkage ourselves inside an interactive lab.