How to Read a Financial Report, 9th Edition

4FITTING TOGETHER FINANCIAL STATEMENTS

Chapters 2 and 3 introduce the balance sheet, income statement, and statement of cash flows for a business example, as you would see these three primary financial statements in a financial report. Each statement stands alone, by itself, on a separate page in the financial report. Each statement is presented like a tub standing on its own feet. The connections between the three financial statements are not made explicit. There is no clear trail of the crossover effects between the three financial statements. But, in fact, there are dual effects—specifically, what happens in one statement also happens in another financial statement. In this chapter we explain how the financial statements interrelate.

One Problem in Financial Reporting

When preparing a financial report, accountants assume that the readers understand the interactions and mutual dependencies among the financial statements that constitute the core of the financial report. Accountants also assume that readers make use of these connections in analyzing the financial affairs of the business. Accountants assume a lot, don’t they? Financial report readers can easily miss the vital interplay among the income statement, balance sheet, and statement of cash flows.

Exhibit 4.1 lays out the connections between the income statement and the balance sheet. This exhibit shows the lines of connection between sales revenue and expenses and their corresponding assets and liabilities. Exhibit ...