Useful Layout to See the Interlocking Nature of Financial Statements

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Please see Exhibit D on page 18. The balance sheet and income statement for this business are introduced in Exhibits B and C in Chapter 2. The cash flow statement is presented for the first time here. The cash flows of the company for the year are discussed in Chapter 1, and are presented in an informal summary (Exhibit A). The actual cash flow statement of the business is now shown in Exhibit D.

Exhibit D shows the general flow of connections between the three financial statements. Sales revenue and expenses cause changes in balance sheet accounts—from accounts receivable through income tax payable. These same accounts affect cash flow. The balance sheet is positioned in the middle and is shown in a vertical format, called the ''report form"—assets on top, and liabilities and stockholders' equity below. The income statement is placed on the left side and the cash flow statement on the right.

In Exhibit D, accounts payable and accrued expenses are each divided into two parts because there are two separate sources for each of these liabilities. The lines of connection between specific accounts are explained in the following chapters.

The three primary financial statements are lashed together in Exhibit D. The connections among the three are presented like a road map showing the highways between the statements, or how to get from one statement to another.

Let me be clear that financial statements are not reported to business managers or to creditors and investors as shown in Exhibit D. Accountants assume that financial statement readers mentally fill in the connections shown in Exhibit D. Accountants assume too much. It takes a fair amount of understanding and experience to know which relationships to look for and which comparisons to make. In any case, Exhibit D's layout is very helpful for explaining financial statements.

Exhibit D looks rather formidable at first glance, doesn't it? Like most reports with a lot of detail, you have to take it one piece at a time rather than in one quick sweep. It's like looking at a chessboard in the middle of a game. You have to study each piece in relation to the other pieces before you can see the overall pattern and situation.

We'll move carefully through each connection, one at a time, in the following chapters. For example, Chapter 4 explores the linkage between sales revenue in the income statement and accounts receivable in the balance sheet. Chapter 13 looks at how the increase in the company's accounts receivable during the year affected cash flow from its profit-making operations.




E amir-gs Per Shnre


Bales Rever.ue


Cose ol Gcodt So'd EsfHinEU


Gross Margin

5 3.&1Ü.OOQ

Operiling E*pfnsaF


□eorBciat:Dn Expense


Openallnn £f.rnln(|s

£ i .¡jûû.irao

Interest Expense


Eami«9£ bticrt income Tiix

i 1,197,000

Income Tax Expense


Wei Income

J ? tE.SCD

E amir-gs Per Shnre

TivC talos rCv&fluO ¡e, urncJ.ened at yea:- End : 5.'52 K $10,-100,000 5l,Q<JO,OOQ


Cash S 565,507

* Accour;1s nsccivatrlo 1 .000 .000

Inventory 1.630.000

PfDpait) Expe«5tS 160.000

F'ropariy, Flint s Eduiintent 3,ooo.oo0

Accumulate! Doprcciallon (nnc.nw}

To'al Assets 5S.615.907

Llabilllios and Ownt-rs Eqully

Account Payable— Inventory S 520.000

AOcomflfi Payable—Operating Expenae-s 120,Li

Awrutd Operating Expanses 240.G0D

Accrued Interest Payable 17,167

Income Tax Payable 23.94D

Short-Term Notes Payable 025,000

Long-Term Noles Payable 7SO.COO

Capita; Siack (203,030 shares! 775,000

Retained Earnings £.54-1.700

Ttlal Liabilities and Owners E£qui:/ i5.6l 5.S07

Sales Revenue and Accounts Receivable

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