The Full Link: From Net Income to a Balanced Balance Sheet
Time to apply it. The interactive lab below follows the same logic as Noor Trading Co., and demonstrates the full linkage:
- Net income feeds cash from operations, and increases retained earnings on the balance sheet after subtracting any dividends.
- Depreciation is added back on the cash flow statement since it’s non-cash, and it reduces net PP&E on the balance sheet.
- Capex flows out as an investing outflow, and increases net PP&E.
- Ending cash on the cash flow statement equals the cash line in the balance sheet’s assets.
Try moving any assumption (growth rate, gross margin, Capex…) and watch the “Balanced ✓” indicator below — it will always stay green, because that’s the essence of correct financial modeling: whatever assumption you change, the three statements must remain in balance with each other.
Assumptions
Simplified for teaching: change in working capital is held at zero, and there is no new debt or equity issuance.
Income Statement
Cash Flow Statement
Balance Sheet
Something to think about
If you increase Capex without changing anything else, ending cash will fall. Why does the balance sheet still balance even though cash goes down? (Answer: because net PP&E increases by exactly the amount cash decreased — total assets don’t change, only their composition does.)
Ready to apply this yourself in Excel? Download the exercise template from the course overview page, or move on to the glossary and the case study.