The income statement, balance sheet, and cash flow statement are three core financial documents that provide different views of a company's financial health. Understanding them individually and how they connect is crucial for assessing a business's performance.
1. Income Statement (The "Profit & Loss" or "P&L" Statement)
The income statement shows a company's profitability over a specific period, like a month, quarter, or year. Think of it as a video recording of the company's financial performance during that time.
- Primary Question Answered: "How profitable was the company?"
- Time Frame: A period of time (e.g., January 1 to December 31).
- Core Formula: Revenues - Expenses = Net Income.
2. Balance Sheet (The "Statement of Financial Position")
The balance sheet provides a snapshot of a company's financial health at a single point in time. It reveals what a company owns and what it owes.
- Primary Question Answered: "What is the company's net worth?" or "What does the company own and owe?"
- Time Frame: A single point in time (e.g., as of December 31).
- Core Formula: Assets = Liabilities + Shareholders' Equity. This equation must always balance.
3. Cash Flow Statement (CFS)
The cash flow statement tracks the movement of cash both into and out of the company over a period. It is crucial because profit on an income statement doesn't always equal cash in the bank, due to non-cash expenses like depreciation and credit sales.
- Primary Question Answered: "Where did the company's cash come from and where did it go?"
- Time Frame: A period of time (e.g., January 1 to December 31).
- Core Formula: Cash from Operations + Cash from Investing + Cash from Financing = Net Change in Cash.
Key Differences Summarized
| Feature | Income Statement | Balance Sheet | Cash Flow Statement |
|---|---|---|---|
| Purpose | Shows profitability | Shows financial position/net worth | Shows sources and uses of cash |
| Time Frame | Period of time | Single point in time | Period of time |
| Core Equation | Revenue - Expenses = Net Income | Assets = Liabilities + Equity | Beginning Cash + Net Cash Flow = Ending Cash |
| Accounting Basis | Accrual | Accrual | _Cash |
How They Are All Connected
The three statements are intricately linked and tell a cohesive story about a company's financial health:
- Net Income Links the Income Statement to the Other Two:
- The Net Income from the income statement is the starting point for the Cash Flow Statement's operating activities section.
- The Net Income also flows into the Balance Sheet under Shareholders' Equity as "Retained Earnings" (profits that are reinvested in the company).
- The Cash Flow Statement and Balance Sheet are Linked:
- The ending cash balance on the Cash Flow Statement is the cash figure shown in the assets section of the Balance Sheet for that period.
- Changes in balance sheet items like inventory, accounts receivable, and accounts payable are used to calculate the cash flow from operations on the Cash Flow Statement.
- Activities like buying equipment (investing) or taking out a loan (financing) on the Cash Flow Statement directly impact the assets and liabilities on the Balance Sheet.