Link Between Cash Flow Statement and Income Statement

In the preparation of a company’s cash flow statement, data from both its income statement and balance sheet is utilized.

An understanding of the linkages among the cash flow statement, income statement, and balance sheet is useful for understanding a company’s financial health. It is instrumental in the detection of any accounting irregularities.

Linkages of the Cash Flow Statement with the Income Statement and the Balance Sheet

The important linkages among the cash flow statement, income statement, and the balance sheet include the following:

• 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 receipts from operating, investing, and financing activities – Cash payments for operating, investing, and financing activities = Ending cash balance

• The current assets and current liabilities sections of the balance sheet reflect a company’s operating decisions and activities. Any differences between the accrual basis and cash basis of accounting for an operating transaction will result in an increment or decrement in a short-term asset or liability on the balance sheet.

• The investing activities of a company usually relate to the long-term asset section of the balance sheet, while its financing activities usually relate to the equity and long-term debt sections of the balance sheet.

Question 1

When computing the ending cash balance reported on the balance sheet, which of the following is 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 because cash receipts are added to, not subtracted from, the beginning cash balance.

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

Question 2

YY Inc. reported the following information in its latest financial statements:

Accounts receivables: $100,000

Revenues: $300,000

Knowing that accounts receivable balance during the prior period was $150,000, how much money did the company collect from its customers?

1. $50,000
2. $150,000
3. $350,000

Solution

The correct answer is C.

$$\begin{align} \text{Cash collected during the period}=& \text{Accounts receivable balance at the prior period}-\\ &\text{Accounts receivable balance at the same period}+\\ &\text{Revenue generated during the same period} \\ =& \$150,000-\$100,000+\$300,000 = \$350,000\end{align}$$