Connect Financials

What Are the Uses of The Three Financial Statements?

In the prior articles, the functions of the three financial statements are introduced. Here, we will first walk through a fast recap on the use and content of the three statements:

• Income Statement: shows the revenue, expense, and profitability during the reporting period
• Balance Sheet: shows the asset, liabilities, and shareholders’ equities at the end of the reporting period
• Cash Flow Statement: shows the business’s cash related to the operation, investing, and financing activities

How Are the Three Financial Statements Connected?

The three financial statements are interconnected, and together they illustrate the story of a company’s financial condition in the past year (or a period of time). They are linked in different aspects, and many items flow through the three financial statements.

Take net income as an example. It is the bottom line of the income statement and shows information related to the company’s profitability. It also flows into the retained earnings under the equity section on the balance sheet. Specifically, retain earnings are calculated by subtracting dividends from net income. Net income also flows into the cash flow statement and is listed as the first line of the “Cash Flow From Operations “ section. Therefore, if the company’s net income on the income statement changes, it will also affect the balance sheet and cash flow statement.

In other words, most items on one financial statement will occur (either in the same name or other forms) on more than one financial statement. This emphasized the connection between the three financial statements and the importance of viewing them holistically when performing financial analysis. Below is a picture that summarizes the detailed relationship between the three financial statements:

The connection between the three financial statements can also be widely used in modeling when an investor is trying to make future forecasts based on historical financials.