9/3/2018 How the 3 Financial Statements are Linked Together - Step by Step

How are the 3 Financial Statements Linked?

The 3 nancial statements are all linked and dependent on each other.  In nancial
modeling, your rst job is to link all three statements together in Excel, so it’s critical to
understand how they’re connected.  This is also a common question for investment
banking interviews, FP&A interviews, and equity research interviews.  See
CFI’s free interview guides to learn more.

In this tutorial, we will break it down for you step-by-step, although we assume you
already have a basic understanding of accounting fundamentals and know how to read
nancial statements.

Want to see a live demonstration?  Watch CFI’s free webinar on how to link the 3 nancial
statements in Excel.

 
https://corporatefinanceinstitute.com/resources/knowledge/accounting/3-financial-statements-linked/ 1/7
9/3/2018 How the 3 Financial Statements are Linked Together - Step by Step

Accounting Principles
The income statement is not prepared on a cash basis – that means accounting
principles such as revenue recognition, matching, and accruals can make the income
statement very di erent from the cash ow statement of the business.  If a company
prepared its income statement entirely on a cash basis (i.e., no accounts receivable,
nothing capitalized, etc.) it would have no balance sheet other than shareholders’ equity
and cash.

It’s the creation of the balance sheet through accounting principles that leads to the rise
of the cash ow statement.

Net Income & Retained Earnings

Net income from the bottom of the income statement links to the balance sheet and cash
ow statement.  On the balance sheet, it feeds into retained earnings and on the cash
ow statement, it is the starting point for the cash from operations section.

 
https://corporatefinanceinstitute.com/resources/knowledge/accounting/3-financial-statements-linked/ 2/7
9/3/2018 How the 3 Financial Statements are Linked Together - Step by Step

PP&E, Depreciation, and Capex

Depreciation and other capitalized expenses on the income statement need to be added
back to net income to calculate the cash ow from operations.  Depreciation ows out of
the balance sheet from Property Plant and Equipment (PP&E) onto the income statement
as an expense, and then gets added back in the cash ow statement.

For this section of linking the 3 nancial statements, it’s important to build a separate
depreciation schedule.

Capital expenditures add to the PP&E account on the balance sheet and ow through
cash from investing on the cash ow statement.

https://corporatefinanceinstitute.com/resources/knowledge/accounting/3-financial-statements-linked/ 3/7
9/3/2018 How the 3 Financial Statements are Linked Together - Step by Step

Working Capital
Modeling net working capital can sometimes be confusing.  Changes in current assets
and current liabilities on the balance sheet are related to revenues and expenses on the
income statement but need to be adjusted on the cash ow statement to re ect the
actual amount of cash received or spent by the business.  In order to do this, we create a
separate section that calculates the changes in net working capital.

See a live demonstration of linking the three statements to learn more.

Financing
This can be a tricky part of linking the three statements and requires some additional
schedules.  Financing events such as issuing debt a ect all three statements in the
following way: the interest expense appears on the income statement, the principal
amount of debt owed sits on the balance sheet, and the change in the principal amount
owed is re ected on the cash from nancing section of the cash ow statement.

https://corporatefinanceinstitute.com/resources/knowledge/accounting/3-financial-statements-linked/ 4/7
9/3/2018 How the 3 Financial Statements are Linked Together - Step by Step

In this section, it’s often necessary to model a debt schedule to build in the necessary
detail that’s required.

Cash Balance
This is the nal step in linking the 3 nancial statements. Once all of the above items are
linked up properly, the sum of cash from operations, cash from investing, and cash from
nancing are added to the prior period closing cash balance, and the result becomes the
current period closing cash balance on the balance sheet.

This is the moment of truth when you discover whether or not your balance sheet
balances!

How to Answer the Question in an Interview

If you get an interview question along the lines of, “How are the 3 nancial statements
linked together?” in an interview you shouldn’t go into as much detail as above, but
instead simply hit the main points, which are:

Net income from the income statement owing to the balance sheet and cash ow
statement
Depreciation is added back and CapEx is deduced on the cash ow statement, which
determines PP&E on the balance sheet
Financing activities mostly a ect the balance sheet and cash from nalizing, except
for interest which is shown on the income statement
The sum of the last period’s closing cash plus this periods cash from operations,
investing, and nancing is the closing cash balance on the balance sheet

If you want to see a video-based example, watch CFI’s webinar on linking the 3 statements.

How to Link the Financial Statements for Financial Modeling

If you’re building a nancial model in Excel it’s critical to be able to quickly link the three
statements. In order to do this, there are a few basic steps to follow:

1. Enter at least 3 years of historical nancial information for the 3 nancial statements
2. Calculate the drivers/ratios of the business for the historical period
3. Enter assumptions about what the drivers will be in the future
4. Build and link the nancial statements following the principles discussed above
https://corporatefinanceinstitute.com/resources/knowledge/accounting/3-financial-statements-linked/ 5/7
9/3/2018 How the 3 Financial Statements are Linked Together - Step by Step

The model essentially inverts, where the historical period is hardcodes for the statements
and calculations for the drivers, then the forecast is hardcodes for the drivers and
calculations for the nancial statements.

Check out CFI’s step-by-step courses to learn how to build nancial models in Excel.

Video of Linking the 3 Statements

Watch CFI’s live video demonstration of linking the statements together in Excel.

More Financial Resources

We hope this has been a helpful guide on how the 3 nancial statements are linked
together. To keep learning more, please check out these relevant resources:

Free cash ow

https://corporatefinanceinstitute.com/resources/knowledge/accounting/3-financial-statements-linked/ 6/7
9/3/2018 How the 3 Financial Statements are Linked Together - Step by Step

EBITDA
Debt schedule
Complete nancial modeling guide
3 statement model
DCF model guide
Types of nancial models

Free Accounting Courses

Learn accounting fundamentals and how to read nancial statements with CFI's free
online accounting classes. These courses will give the con dence you need to perform
world-class nancial analyst work. Start now!  

Building con dence in your accounting skills is easy with CFI courses! Enroll now for FREE
to start advancing your career!

https://corporatefinanceinstitute.com/resources/knowledge/accounting/3-financial-statements-linked/ 7/7