Linking the Three Statements

The three financial statements are not independent documents, they are three views of the same underlying reality. Changes in one always ripple through the others. Understanding these linkages is the foundation of financial modelling and analysis.

When a company earns a profit, that profit flows into retained earnings on the balance sheet (via shareholders' equity). When it spends on assets, those appear on the balance sheet and the purchase is shown in investing cash flows. When it depreciates those assets, a non-cash charge reduces the P&L profit but gets added back in operating cash flows.

Building a linked 3-statement model, even a simple one, is the fastest way to internalise these connections. Breaking a link in the model shows you exactly how the statements depend on each other.

Key linkages:

P&L → Balance Sheet

• PAT flows into Retained Earnings (part of Equity). Dividends paid reduce Retained Earnings.
• D&A on the P&L reduces the net book value of PP&E on the balance sheet.
• Tax expense on P&L creates current tax payable (liability) and deferred tax (asset or liability).

Balance Sheet → Cash Flow Statement

• Working capital changes on the balance sheet drive CFO adjustments. If trade receivables increased by ₹50 Cr, CFO is reduced by ₹50 Cr.
• Capex (purchase of PP&E) increases assets on the balance sheet and appears as an outflow in CFI.
• New borrowings increase liabilities and appear as inflows in CFF; repayments reduce liabilities and are outflows in CFF.

Cash Flow Statement → Balance Sheet

• The net change in cash (CFO + CFI + CFF) reconciles the opening and closing cash balances on the balance sheet.

The closing cash balance on the balance sheet must equal the cash per the cash flow statement, always. This is the key check in any model.