By Victor Paquet (Mergersight Operations) and Carlo Lepoardi & Tommaso Arona (Boston University partners)
The financial statements all work together to help provide information about a company’s financials to key decision makers. When preparing the three financial statements prepare first the Income Statement, then Balance Sheet, and finally the Cash Flow Statement to follow the workflow.
The Income Statement reports revenues and expenses of a company over time. The top line is revenue while taking away the Cost of Goods Sold (COGS), operating expenses (e.g. Selling General & Administrative, Rent, Utilities), interest expenses, and tax expenses you get to the bottom line, net income. Net income flows from the bottom of the income statement to the top of the cash flow statement.
The Balance Sheet
The balance sheet is a snapshot in a single moment in time of all the Assets (what you own), Liabilities (what you owe), and Shareholder’s Equity (Ownership Interest) in balance. The period's ending balance of Cash calculated at the bottom of the Cash Flow Statement is then recorded as a current asset back on to the balance sheet as a permanent account.
The Cash Flow Statement
The purpose of the Cash Flow Statement is to look at a company’s total inflows and outflows of cash over time, giving an indication of the health of the business’s operations.
Working our way down the Cash Flow Statement from net income, add back non-cash expenses (e.g. Depreciation & Amortization and stock-based compensation), and then subtract the change in Net Working Capital (NWC = Current Assets - Current Liabilities) to find the cash from operating activities.
Non-cash expenses are line items present on the income statement, they are tax-deductible GAAP line items that follow the accrual basis of accounting and do not represent an exchange of cash, thus needed to be added back in the Cash Flow Statement.
Two other key sections of the Cash Flow statement include cash from investing and financing activities. Cash from investing activities can be derived from long-term assets, while cash flow from financing activities can be found from the Liabilities and Shareholder’s Equity accounts, all present on the balance sheet along with the current assets and liabilities used to calculate the Net Working Capital (NWC).