🕯️ [INT. FINACADEMICS STUDY – LAMPS LIT]
Watson leans over a stack of ledgers. Holmes, teacup in hand, peers over a set of three aged parchment scrolls: P&L, Balance Sheet, and Cash Flow Statement.
WATSON:
Sherlock, I’ve finally wrapped my head around these three reports, but they feel like strangers at a party — each talking, none listening.
HOLMES:
Ah, Watson. That’s where the case begins. Alone, each statement can mislead. Together? They reveal the truth behind the veil. Let us decode their connections.
📚 Why You Must Connect the Statements
Think of the P&L, Balance Sheet, and Cash Flow as three acts in a financial play. Each tells a part of the story:
- Income Statement: Did we earn money?
- Balance Sheet: What do we have, and what do we owe?
- Cash Flow: Where did the money actually go?
Understanding how they link is where finance becomes forensics.
🧾 1. Net Income Feeds Retained Earnings
Net Income, the final figure on the P&L, is transferred into Retained Earnings in the Equity section of the Balance Sheet.
It’s how profit accumulates over time — unless distributed as dividends.
🔁 2. Depreciation Appears in All Three
- Income Statement: Reduces taxable income as an expense
- Cash Flow: Added back in Operating Activities
- Balance Sheet: Lowers asset value through accumulated depreciation
Like a phantom cost — felt in form, not in cash.
🏗️ 3. Capital Expenditure (CapEx)
Buying an asset like a machine doesn’t hit the Income Statement — it appears:
- Cash Flow Statement: Outflow under Investing Activities
- Balance Sheet: Increase in Property, Plant & Equipment (PP&E)
Its impact filters in slowly — via depreciation over years.
🔄 4. Working Capital Effects
If you record revenue but haven’t received payment, cash doesn’t flow.
- Income Statement: Shows full revenue
- Balance Sheet: Increase in Accounts Receivable
- Cash Flow Statement: Cash deducted as working capital increase
A classic illusion: profit without cash.
💸 5. Loans, Dividends & Shares
All major moves appear on Cash Flow and Balance Sheet — yet skip the P&L entirely.
| Activity | Cash Flow | Balance Sheet | P&L |
|---|---|---|---|
| Loan Received | Increase (Financing) | Increase in Liabilities | None |
| Dividend Paid | Decrease (Financing) | Decrease in Retained Earnings | None |
| Shares Issued | Increase (Financing) | Increase in Equity | None |
📊 Mini Case – Connected Flow
| Metric | 2022 | 2023 | Note |
|---|---|---|---|
| Net Income | 300,000 | 450,000 | P&L |
| Accounts Receivable | 200,000 | 400,000 | Balance Sheet (warning!) |
| Operating Cash Flow | 150,000 | 50,000 | CF decline despite profit growth |
🧠 Why This Matters
- Only by linking all three do you understand true performance
- Poor cash flow with high income = liquidity trap
- High CapEx with low OCF = long-term risk
- Growth in receivables = slow-paying customers or revenue manipulation
🧪 TL;DR Table – Key Connections
| Link | From | To |
|---|---|---|
| Net Income → Retained Earnings | P&L | Balance Sheet |
| Depreciation → Add-back & Asset Drop | IS & CF | Balance Sheet |
| CapEx → Fixed Asset | CF Investing | Balance Sheet |
| Receivables Increase → Less Cash | Balance Sheet | CF Ops |
| Loans/Shares/Dividends | Cash Flow | Balance Sheet |
🧠 Detective’s Note: One report may flatter. But the trilogy never lies. Always follow the trail between statements.
“It is a capital mistake to theorize before one has data.”
— Sherlock Holmes, A Study in Scarlet
Investigative Author: Dr. Watson & Co.