Basic Accounting:
The Balance Sheet and the Cash Flow Statement
What do these two statements have in common, other than they happen to be a part of the Financial Statement set? At first glance, to the untrained eye, there would be very little common ground; but if you’re an accountant, you know that the Balance Sheet and the Statement of Cash Flow share interdependence. What is it, and what is the significance?
The interdependence shared by the Balance Sheet and the Statement of Cash Flows can be found in the investing and financing section of the Statement of Cash Flows and the Assets and Liabilities areas of the Balance Sheet.
When changes occur in the assets of a business, these changes are reflected in the asset values reported on the Balance sheet. Quite often, purchases of equipment, machinery, buildings, and property are necessary. A purchase increases the fixed asset value of the company; it is also a change that is reflected in the Net Cash from investing activity. When a company spends money to purchase equipment, machinery, buildings or property, if the money spent is taken from cash, there will be a significant change in this area of the Statement of Cash Flows. If the money is borrowed, there will be a significant change in the Net Cash from financing activity.
Changes found in these areas should flag the need for further examination of the Balance sheet in order to accurately assess the actual financial condition of the business. When you see significant changes in the balances for the financing and investing totals, there should also be changes in the assets and liabilities area of the Balance sheet.
The notes that are incorporated into the Financial Statements data should provide anyone (accountant or investor) with enough information to accurately assess the impact of the change, either positive or negative. If you studied the sample Statement of Cash Flows provided at the beginning of this series, you saw references to these notes that looked like this (note 5); these notes are incorporated into the actual statement, along with as much explanation as possible, so that anyone performing an evaluation can quite easily determine the sequence of events.
Changes in the Net Cash from Operating activities area of the Statement of Cash Flows will also affect the Balance sheet; if these changes affect owner equity, increases or decreases in asset or liability values then there will also be changes on the Balance Sheet.
The Financial Statements set of information is designed to give the examiner, investor, auditor, or business owner a picture of the overall health of the business. Each statement holds some interdependence upon the other. The information that is reported in one statement will either directly or indirectly affect the information that is reported on the other statements. The Income statement directly impacts the Statement of Owner Equity; the Income statement also provides information for the Statement of Cash Flows; but the Balance Sheet and Statement of Cash flows share a larger interdependence than any of the remaining statements.
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