What are the three financial statements and how do they link?

The three statements are the income statement, the balance sheet, and the cash flow statement. They link through three primary connections.

Income statement first. It tells you whether the business made money over a period — revenue at the top, then cost of goods sold to get gross profit, operating expenses to get operating income / EBIT, then interest expense and taxes to get net income at the bottom. It's an accrual statement: it captures economic activity, not cash.

The cash flow statement reconciles accrual net income to actual cash movement. It starts with net income from the income statement (link one), then adjusts in three sections. Operating activities: add back non-cash items like D&A, then adjust for changes in working capital. Investing: CapEx, acquisitions, divestitures. Financing: debt issuance and repayment, equity issuance, dividends. The bottom line is the change in cash for the period.

The balance sheet is a point-in-time snapshot of what the company owns and owes. Assets equal liabilities plus equity, always. The cash flow statement's ending cash balance is the cash line on the balance sheet (link two). Net income flows from the income statement into retained earnings within equity on the balance sheet (link three) — net income increases retained earnings, dividends decrease it.

The loop also runs through specific line items. CapEx on the cash flow statement increases PP&E on the balance sheet. D&A on the income statement reduces PP&E. Debt issuance on the cash flow statement increases the debt line on the balance sheet. The balance sheet has to balance — if it doesn't, one of the linkages is broken.

That's why you build the model in this order: project the income statement, project the cash flow drivers, then derive the balance sheet, and check that it balances.