7 June 2011

Demystifying The Financial Statement Relationship

This is the final post in the financial statement series, where I will explain how all of the various financial statements link together, to help you to use them to analyse companies/investments and their real worth. Before reading this you may want to check out the other posts in this series to help your understanding of the financial statements relationship.

Income statement [Links to Balance sheet]

The income statement and the figures it represents all the way down to the net income comes from the Balance Sheet.

With reference to the net income, the amount that isn’t paid out via dividends to shareholders is kept as retained earnings, which is an entry under the shareholders equity portion of the Balance Sheet. Obviously the balance sheet will move accordingly to make sure that the asset and liability sections still balance out. 

Cashflow statement [links to the Income Statement]

The net income is the main entry under operating activities within the Cashflow Statement, and this figure comes directly from the Income Statement. 

Adjustments can be made to the operating income by making allowances for thing that may not have been included such as depreciation or the sale of an investment. Any dividend that is paid out will also be captured on the Cashflow Statement in the financing section.

Balance sheet [links to the Income Statement]

The Balance Sheet is linked to the Income Statement in terms of its retained earnings. Any changes in investments etc will also be captured here.

Footnotes are usually found on the bottom of financial statements which can highlight additional information but by analysing all three statements and understanding how they all link together a deeper understanding can be gleaned. 

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