Links Between Financial Statements in a Business Plan

The financial projections template produces an income statement, balance sheet, and cash flow statement which at first glance appear to be separate independent statements. However, a closer look reveals that there are in fact links between financial statements.

 

When preparing financial projections for a business plan it is important to understand how a change in one statement can impact another. For example, a change in net income shown in the income statement has an impact on cash flow shown in the cash flow statement and corresponding impacts on cash and retained earnings shown in the balance sheet at the end of the year.

Links Between Financial Statements Example

The links between financial statements can best be seen by reviewing the trading operations of a typical business.

Each accounting period (usually a year) starts with a beginning balance sheet on the first day of the period and finishes with an ending balance sheet on the last day of the period. The financial activity of the business between the two balance sheet dates is reflected in the income statement and the cash flow statement.

The highlighted items indicate the various links between financial statements which are more fully discussed below.

Beginning Balance Sheet

The balance sheet or statement of financial position, shows the assets, liabilities and equity of the business at a specific point in time. In this case the balance sheet is taken at the start of the year before any trading activity takes place.

Beginning Balance Sheet at 1 January 2017
Cash 8,000
Other assets 30,000
Total assets 38,000
Liabilities 26,000
Capital 5,000
Retained earnings 7,000
Total liabilities and equity 38,000

Income Statement for the Year

The income statement shows the financial performance of the business between the beginning and ending balance sheet dates in terms of its revenue, expenses, and net income. The income statement is sometimes referred to as the profit and loss statement.
Income Statement for the Year to 31 December 2017
Revenue 90,000
Expenses 80,848
Net income 9,152

 

Cash Flow Statement for the Year

The cash flow statement or statement of cash flows shows the cash inflows and cash outflows of the business during the year between the two balance sheet dates.

Cash Flow Statement for the Year to 31 December 2017
Beginning cash balance 8,000
Net income 9,152
Depreciation 4,000
Working capital -3,340
Operating cash flow 9,812
Investing cash flow -2,000
Financing cash flow -2,519
Net cash flow 5,293
Ending cash balance 13,293

Ending Balance Sheet

The ending balance sheet is in the same form as the beginning balance sheet. Again it shows the assets, liabilities and equity of the business at a specific point in time, in this case at the end of the financial period.

Ending Balance Sheet at 31 December 2017
Cash 13,293
Other assets 31,972
Total assets 45,265
Liabilities 25,113
Capital 5,000
Retained earnings 15,152
Total liabilities and equity 45,265

How do Financial Statements Link Together?

There are various links between financial statements each of which is discussed in more detail below.

Link Between Balance Sheet and Income Statement

The net income shown in the income statement of (9,152) is the earnings the business has generated during the year. These earnings are accumulated together retained earnings from the beginning balance sheet (7,000) and either paid out to shareholders by way of dividend or retained by the business.

The statement of retained earnings is used to summarize this movement as shown below.

Statement of Retained Earnings at 31 December 2017
Net income 9,152
Beginning retained earnings 7,000
Less: Dividends -1,000
Ending retained earnings 15,152

The statement of retained earnings effectively links the net income shown in the income statement to the balance sheet. The accumulated balance of retained earnings from the statement (15,152) is included in the ending balance sheet and forms part of the equity of the business.

Link between the Income Statement and the Cash Flow Statement

The net income (9,152) from the income statement is also the starting point for the indirect method cash flow statement.

Referring to the cash flow statement shown above, by adjusting the net income for non-cash items such as depreciation, and for movements in working capital requirements, the business can determine its cash flow from operating activities. The operating cash flow together with the investing and financing cash flows determine the net cash flow of the business for the year (5,293).

Link Between Balance Sheet and Cash Flow Statement

The cash flow statement is completed by adding the cash from the beginning balance sheet (8,000) to the cash movement for the year (5,193) to give the ending cash balance of (13,293). This final cash amount is included in the ending balance sheet under the heading of cash and forms part of the assets of the business.

Summary

The links between financial statements discussed above are summarized in the diagram below.

Links Between Financial Statements
Links Between Financial Statements (click to zoom)

Referring to the numbers highlighted in red on the diagram.

  1. Net income from the income statement is used in the statement of retained earnings.
  2. Retained earnings from the beginning balance sheet is added to net income using the retained earnings statement.
  3. The retained earnings statement final balance is included in the ending balance sheet.
  4. Net income from the income statement is also used as the starting point for the cash flow statement.
  5. Cash from the beginning balance sheet is used in the cash flow statement.
  6. The cash flow statement final balance is included in the ending balance sheet.
Links Between Financial Statements in a Business Plan June 6th, 2018Team

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