How do the three financial statements connect?

The connection between the three financial statements—Income Statement, Balance Sheet, and Cash Flow Statement—is crucial for understanding a company's financial health. The Income Statement provides the net income figure, which is a vital component for both the Balance Sheet and the Cash Flow Statement.

Net income from the Income Statement is linked to the Balance Sheet through retained earnings, which is part of shareholders’ equity. Retained earnings represent the cumulative net income that has been reinvested in the business rather than distributed as dividends. This means that net income directly impacts the equity section of the Balance Sheet, allowing investors and stakeholders to see how much of the profit is being retained within the company for growth or reinvestment.

Furthermore, net income plays a significant role in the Cash Flow Statement, as it serves as the starting point for the cash flow from operating activities. Adjustments are made to net income to account for non-cash items (like depreciation) and changes in working capital in order to arrive at the actual cash generated or used by the company's operating activities over a specific period.

This clear linkage through net income demonstrates how the three financial statements are interrelated, providing a comprehensive view of a company's financial performance and position.