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.
|Total liabilities and equity||38,000|
Income Statement for the Year
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.
|Beginning cash balance||8,000|
|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.
|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.
|Beginning retained earnings||7,000|
|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.
The links between financial statements discussed above are summarized in the diagram below.
Referring to the numbers highlighted in red on the diagram.
- Net income from the income statement is used in the statement of retained earnings.
- Retained earnings from the beginning balance sheet is added to net income using the retained earnings statement.
- The retained earnings statement final balance is included in the ending balance sheet.
- Net income from the income statement is also used as the starting point for the cash flow statement.
- Cash from the beginning balance sheet is used in the cash flow statement.
- The cash flow statement final balance is included in the ending balance sheet.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.