Now we have our three financial statements. They do different things: the P&L is Sales, the Past; Cash Flow is Cash, the Present; the Balance Sheet is Stuff, the Future.
But they're all connected. Cash Flow is really just the change in each Balance Sheet amount since the last period. Another way they connect is what I call the Waterfall: the bottom line of the P&L is the top line of Cash Flow, and the bottom line of Cash Flow is the top line of the Balance Sheet.
For my money, the most interesting connection is how Net Income on the P&L not only becomes the top line of Cash Flow but also flows into Retained Earnings on the Balance Sheet.
The Light Up Demo
Pick a transaction and watch which lines of the three statements it touches. Green means the number goes up; red means it goes down. Every number comes from the same sample company, and every transaction is checked: the Balance Sheet still balances, Cash Flow still lands on the cash, and Net Income still reaches Retained Earnings.
Sales
Costs
Assets
Loans
Owners
Goes UpGoes Down
P&L
Revenue$20,000
Bad Debt / Returns$400
Net Revenue$19,600
COGS$8,000
Gross Profit$11,600
Sales and Marketing Expenses$2,000
Operating Expenses$6,000
EBITDA$3,600
Interest Expense$100
Taxes$600
Depreciation$300
Amortization$100
Net Income$2,500
Cash Flow
Net Income$2,500
Depreciation$300
Amortization$100
Receivables$400
Inventory$8,000
Payables$0
Operating Activities$11,300
Fixed Assets$0
Intangible Assets$0
Investing Activities$0
Short-Term Debt$0
Long-Term Debt$0
Preferred$0
Common$0
Dividends / Distributions$0
Financing Activities$0
Net Change in Cash$11,300
Beginning of Period$50,000
End of Period$61,300
Balance Sheet
Cash and Equivalents$61,300
Accounts Receivable$9,600
Inventory$12,000
Total Current Assets$82,900
Intangible Assets$5,000
Accumulated Amortization($1,100)
Net Intangible Assets$3,900
Fixed Assets$30,000
Accumulated Depreciation($6,300)
Net Fixed Assets$23,700
Total Assets$110,500
Accounts Payable$7,000
Short-Term Debt$5,000
Total Current Liabilities$12,000
Long-Term Debt$20,000
Total Liabilities$32,000
Preferred$40,000
Common$10,000
Retained Earnings$28,500
Total Equity$78,500
Total Liabilities and Equity$110,500
Try Sell with Payment Terms, then Sell with Cash. Profit goes up the same either way. Only one of them puts money in the bank. Cash is not profit!
Quick Check
The bottom line of Cash Flow becomes...
End of Period cash is the Balance Sheet’s cash.
Net Income on the P&L also flows into...
Retained Earnings keeps every month’s Net Income.
You sell on payment terms. What happens to cash this month?
Revenue and Accounts Receivable go up; the cash comes when the customer pays.
