How do the 3 statements link together?

How do the 3 statements link together?

• A. The income statement is connected to the balance sheet through retained earnings, and net income flows into retained earnings.
• B. The cash flow statement is not connected to the income statement.
• C. Net income from the income statement flows into the cash flow statement only.
• D. The balance sheet is unaffected by net income.

Answer: (A)

Profits link the three statements through net income. When a company earns net income on the income statement, that amount increases the equity part of the balance sheet as retained earnings, reflecting the accumulated profits kept in the business. At the same time, net income is the starting point for the cash flow statement’s operating activities section (in the indirect method), where non-cash adjustments and changes in working capital are added back or subtracted to convert accrual net income into cash from operations. The resulting cash from operations then feeds into the cash balance on the balance sheet, and over time, movements in net income and cash flow affect assets, liabilities, and retained earnings alike. So the statement that net income flows into retained earnings and that the income statement connects to the cash flow statement captures how these three statements are interlinked.

Profits link the three statements through net income. When a company earns net income on the income statement, that amount increases the equity part of the balance sheet as retained earnings, reflecting the accumulated profits kept in the business. At the same time, net income is the starting point for the cash flow statement’s operating activities section (in the indirect method), where non-cash adjustments and changes in working capital are added back or subtracted to convert accrual net income into cash from operations. The resulting cash from operations then feeds into the cash balance on the balance sheet, and over time, movements in net income and cash flow affect assets, liabilities, and retained earnings alike. So the statement that net income flows into retained earnings and that the income statement connects to the cash flow statement captures how these three statements are interlinked.