Financial statements course · Lesson 5 of 10
Five links tie the three statements together.
The three statements are not three separate reports. They describe the same year from three sides. Each link between them is a check.
The five links
| What moves | From | To | $ millions |
|---|---|---|---|
| Net income | Income statement | First line of the cash flow statement | 137.5 |
| Change in cash | Cash flow statement | Cash on the balance sheet, 114.9 to 150.0 | 35.1 |
| Change in each working capital line | Balance sheet | Operating section of the cash flow statement | (7.4) |
| Capital expenditure less depreciation | Cash flow and income statements | Property and equipment, 360.0 to 400.0 | 40.0 |
| Net income, stock pay and payouts | All three | Shareholders’ equity | 82.5 |
Each link is arithmetic. Net income goes to the top of the cash flow statement. The change in cash goes to the balance sheet. Each change in a working capital line on the balance sheet appears as a line in the cash flow statement.
Property and equipment grows by capital expenditure and falls by depreciation. For Example Co., $360 million plus $80 million less $40 million is $400 million.
The statement of shareholders’ equity
The 10-K has a fourth statement. It shows how equity changed from the start of the year to the end.
| Line | $ millions |
|---|---|
| Start of year | 317.5 |
| Net income | 137.5 |
| Stock pay | 15.0 |
| Dividends | (40.0) |
| Buybacks | (30.0) |
| End of year | 400.0 |
Net income adds to equity. Stock pay adds too, because the company gave shares in place of cash. Dividends and buybacks take cash out to the owners, so they reduce equity.
Check a real company
- Find cash at the start and end of the year on the balance sheet. Compare the change with the last line of the cash flow statement.
- Compare net income on the income statement with the first line of the cash flow statement.
- Find the change in receivables on the balance sheet. Compare it with the line in the cash flow statement.
Small differences are normal for a real company. Acquisitions, exchange rates and reclassified items can move a balance without a line that matches. A large difference that the notes do not explain needs an answer.
Our model checks all five links before it prints a figure. If one link does not tie, the script stops.
Key points
- The three statements describe one year from three sides.
- Five links tie them. Each link is a check.
- The statement of equity shows what added to equity and what took from it.
Sources
- SEC, Beginners’ Guide to Financial Statements, for the balance sheet equation, current items, the three sections of the cash flow statement and the statement of shareholders’ equity.