How do the Financial Statements Flow Together?

Understanding how the three core financial statements interplay is fundamental to your success in investment banking interviews. Below is a brief description of the three statements and how they connect to one another. Following the explanation you will find a few sample interview questions.

Income Statement
Net income--the bottom line--flows from the Income Statement to Retained Earnings on the Balance Sheet. It also becomes the first line of Cash from Operations on the Cash Flow Statement. You can think of the Income Statement as a cumulative record over a period of time.

Balance Sheet
The name of this statement describes its purpose; the Balance Sheet always balances. This financial statement acts as a record for a firm's assets and all the claims against those assets. The remaining value is called Stockholder's Equity. The Cash balance which is the first line item under Current Assets at the top of the Balance Sheet is taken from the Ending Cash on the Cash Flow Statement. The Balance Sheet, unlike the Income Statement, is not a cumulative record over time; it is a snapshot of one moment in time.

Cash Flow Statement
The Cash Flow Statement connects the three financial statements together. The statement begins with Net Income from the Income Statement and the Ending Cash balance at the bottom Cash Flow Statement flows to Cash and Cash Equivalents at the top of the Balance Sheet.

Practice Interview Questions:

Which financial statement is most important?

The answer to this question depends on who is asking but generally the Cash Flow Statement is most crucial. An analyst in Lev Fin (Leveraged Finance) at a bulge bracket in New York explained to me that the Cash Flow Statement defines a firm's financing options. Whether it be a leveraged buyout, dividend distribution, or a restructuring, the Cash Flow Statement tells financiers what their options are. Cash is King!
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If you could only have two of the three core financial statements, which two would you take?

Even though the Cash Flow Statement ties the three statements together, the most important items from the Cash Flow Statement can be derived from the Income Statement and the Balance Sheet. I would take the Income Statement and the Balance Sheet.
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How do the three financial statements flow together?

For this question you should restate the descriptions mentioned above in an abbreviated fashion. Practice this several times out loud and while mock interviewing.