Linking financial statements

The first step in many financial models is linking the different financial statements together. In point of fact, this actually seems trivial. It doesn't seem too hard to put together the income statement with the balance sheet, right. But in reality it can be a lot trickier than you might think. Let's see how it's done. Let's take a look at the steps, shall we. 

So, step one in linking the financial statements, is to begin by calculating our revenue. We're gonna do this based on some kind of a forecasting approach. From there, you need to go through and fill in your other major accounting statement items, so cost of goods sold or COGs, your gross profit, your operating expenses. And then when we get done, you should have your earnings before interest, taxes, depreciation, and amortization, or EBITDA as it's more commonly known. 

Once you've gone through and filled out the financial statement, you're ready to begin creating your supporting schedules. In particular, we don't necessarily talk a lot about supporting schedules in accounting. They're not as widely used or widely known as the balance sheet, the income statement and the cash flow statement, but they are critical. In particular, they're gonna help us to understand the details that are gonna go into each of those major financial statements. So you need to create supporting schedules for your capital assets, and this will tell us what our property, plant and equipment, or PP&E, expenses are. They'll tell us about depreciation, and our capex, or capital expenditures. Then you're gonna have a supporting schedule for your working capital balance. This tells us what level of accounts receivable, and accounts payable we expect, and what level of inventory we have on hand. Finally, you're gonna have a financing schedule. That's gonna tell us, over time, what kind of capital are we raising, is it equity or debt. And then what kind of payments do we need to make to that capital in the form of dividends, interest payments, et cetera. 

Once you've finished with step two, you're ready to go through and fill in the income statement. In particular, you can now finish up by adding in some of the non-cash expenses, like depreciation. And you can also fill out interest and taxes, and that'll leave you with net income. From there you're prepared to fill in the balance sheet items, everything except for cash. Cash is the last part of the financial model that you'll complete. 

Then finally, in step four, you're gonna build out your cash flow statement. Look at all the cash from operating activities. The cash that's used in, or generated by, investing activities. And cash from financing activities. You take these three separate components, cash from operations, cash from investing, and cash from financing, put them all together and that'll give you your closing cash balance. And that should be linked back to the balance sheet, which let's you complete your financial model. 

Now you're prepared to see where the company is going in the weeks, months and years ahead. At this point, hopefully, you understand how to link the financial statements together to start building a comprehensive picture of the firms financial statement, or at least you understand it in principle.