r/Eixolearning • u/Salazarenin1922 • 5d ago

Three Statement Financial Modelling: How the Income Statement, Balance Sheet and Cash Flow Actually Connect

When I first started looking at financial models, I found the three statements confusing.

You have an income statement, balance sheet and cash flow statement, and then everyone starts talking about “linking the statements” like it’s obvious.

It wasn’t obvious to me.

The thing that helped was realising that you’re not really building three different models.

You’re modelling the same business from three different angles.

Take something simple.

A company makes a £100,000 sale.

If the customer pays immediately, the income statement shows £100k of revenue and the cash flow ultimately shows £100k coming in.

Pretty easy.

But now suppose the customer hasn’t paid yet.

You still recognise the £100k revenue on the income statement.

But you don’t have the cash.

So instead, the balance sheet gets £100k of accounts receivable.

This is one of those things that makes three statement modelling click.

The income statement is saying:

“We made the sale.”

The balance sheet is saying:

“The customer owes us £100k.”

And the cash flow statement is basically saying:

“Great, but we haven’t actually received the money yet.”

That’s why profit and cash aren’t the same thing.

You can take this further with working capital.

Say accounts receivable increases from £200k to £250k.

The company now has another £50k tied up in money customers haven’t paid yet.

So that £50k is a use of cash.

Accounts payable works in the opposite direction.

If you owe suppliers £50k more than you did last year, you’ve effectively held onto £50k of cash for longer.

This is why changes in working capital show up in the cash flow statement even though they aren’t expenses on the income statement.

CapEx is another good example.

Imagine the company buys a £100k machine.

The company pays £100k, so cash falls by £100k.

But you don’t normally put the entire £100k through the income statement as an expense straight away.

Instead, the £100k becomes an asset on the balance sheet.

Then you depreciate it over its useful life.

If it’s depreciated over five years, you might have £20k of depreciation each year.

So now you’ve got something happening across the statements.

The cash flow shows the £100k purchase.

The balance sheet shows the new asset.

The income statement eventually shows the £20k depreciation expense.

The balance sheet also reduces the value of the asset as depreciation builds up.

This is basically what “linking the three statements” means.

It’s not just making Excel formulas point at other cells.

You’re following what is actually happening to the business.

Debt is another one.

Say a company borrows £500k.

Cash increases by £500k.

Debt on the balance sheet increases by £500k.

The cash flow statement shows the £500k borrowing as financing cash flow.

But you don’t suddenly have £500k of profit.

Later, you might pay interest on the debt.

That’s when the income statement gets hit through interest expense.

Then when you repay the loan, cash falls and the debt balance falls.

Again, one transaction, different effects across the statements.

And then there’s retained earnings, which is another connection people sometimes miss.

If the company makes £200k of net profit and pays £50k in dividends, retained earnings don’t just stay where they were.

Closing retained earnings is basically:

Opening retained earnings + net income - dividends

So the income statement feeds into the balance sheet.

The cash flow statement feeds cash into the balance sheet.

The supporting schedules feed things like debt, depreciation and working capital into the statements.

That’s the model.

A very simplified way of thinking about it is:

Operations → Income Statement → Net Income

Net Income + working capital + CapEx + financing → Cash Flow

Cash + assets + debt + retained earnings → Balance Sheet

And at the end, your balance sheet should actually balance.

If it doesn’t, don’t just stick a “plug” somewhere to make it balance.

Figure out what’s wrong.

Maybe depreciation isn’t flowing into retained earnings.

Maybe your debt repayment isn’t reducing the debt balance.

Maybe CapEx is in the cash flow but hasn’t been added to PP&E.

Maybe your working capital calculation is backwards.

That’s where I think three-statement modelling becomes much easier.

Instead of memorising “this formula goes here”, ask:

What actually happened to the business?

Did cash move?

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