Link Between Cash Flow Statement and Income and Balance Sheet Statement

Financial statements are interconnected, each serving a unique function in providing detailed information about a company’s financial activities. The four primary financial statements are:

The four primary financial statements are interconnected, each serving a unique function in providing detailed information about a company’s financial activities. These statements include:

• Balance Sheet: Captures the financial status of a company at a specific moment. It details the company’s assets and how these assets are funded through liabilities and shareholders’ equity, representing “permanent” or “stock” accounts.
• Income Statement: Shows the company’s financial performance over a period, bridging two balance sheet dates. Comprising revenues, expenses, gains, and losses, the income statement differs from the balance sheet in that it records transactions over time, hence categorized as a “flow” statement. When prepared under IFRS or US GAAP, it utilizes accrual accounting, which means the reported figures may not directly correspond to cash transactions.
• Statement of Cash Flows: Outlines the changes in cash and cash equivalents, including restricted cash, from one balance sheet date to the next. It organizes cash movements into operating, investing, and financing activities, presenting a timeline of cash inflows and outflows, thus qualifying as another “flow” statement.
• Statement of Shareholders’ Equity: Details changes in the company’s equity between balance sheet periods. It lists key equity components, such as common stock and retained earnings as shown on the balance sheet, alongside descriptions of transactions that affected these components, like share issuance or the results of net income or losses. Similar to the income and cash flow statements, this is also considered a “flow” statement due to its focus on changes over time.

Understanding the linkages among the cash flow statement, income statement, and balance sheet is helpful in assessing a company’s financial health and is instrumental in detecting accounting irregularities.

Linkages between Financial Statements

The balance sheet dates are linked by the income statement, cash flow statement, and the statement of shareholders’ equity, as shown below:

For example, the beginning and ending balance sheet amounts of cash and cash equivalents are linked through the cash flow statement. Specifically, the statement of cash flows shows the change in the cash balance during the reporting period, according to the following equation:

Beginning cash balance + Cash inflows from operating, investing, and financing activities – Cash outflows from operating, investing, and financing activities = Ending cash balance

An example involving a statement of shareholders’ equity involves the retained earnings, as shown below:

Beginning Retained Earnings (balance sheet item) + Net Income (Income statement item)D – Dividends (cash flow item)= Ending Retained Earnings (balance sheet item)

Linkages Between Current and Current Liabilities

Current assets and current liabilities offer insights into a company’s operational choices and activities. Discrepancies between accrual and cash accounting methods in recording these transactions often lead to increases or decreases in these short-term assets or liabilities. For instance, when revenues recognized on an accrual basis exceed actual cash receipts, accounts receivable will increase. Conversely, if expenses recognized accrue faster than cash is disbursed, this will likely result in an increase in accounts payable or other accrued liabilities.

Furthermore, when a company receives payments in advance for services or products to be delivered in the future, it records the cash as an asset but also acknowledges a liability for the impending delivery, commonly known as deferred revenue. This liability is then removed from the books as revenue is recognized upon fulfilling the delivery obligations.

Additionally, a company’s investing activities are generally associated with changes in the long-term assets section of the balance sheet, whereas financing activities typically impact the sections dealing with equity and long-term debt.

Generally, both the income statement and the statement of cash flows play crucial roles in linking the activities reflected in current assets and liabilities with the broader financial picture, demonstrating the interconnectedness of these financial statements in representing a company’s fiscal health and operational efficiency.

For instance, the beginning and the ending accounts receivable are connected as follows:

Beginning Accounts Receivable + Revenue – Cash collected from customers = Ending Accounts Receivable

Question

When computing the ending cash balance reported on the balance sheet, which of the following is most likely accurate?

1. Cash receipts are subtracted from the beginning cash balance.
2. Cash payments are subtracted from the beginning cash balance.
3. Cash receipts and payments are added to the beginning cash balance.

Solution

The correct answer is B.

Cash payments are subtracted from the beginning cash balance in deriving the ending cash balance.

A is incorrect. Cash receipts are added to, not subtracted from, the beginning cash balance.

C is incorrect. Cash payments are subtracted from, not added to, the beginning cash balance.