Walk Me Through the Three Financial Statements

Income statement → Cash flow statement: Net income is the first line of the cash flow statement (top of the operating section). Income statement → Balance sheet: Net income, minus dividends, flows into retained earnings within shareholders' equity. Cash flow statement → Balance sheet: The ending cash balance from the bottom of the cash flow statement becomes the cash line at the top of the balance sheet's assets. Beyond cash, every balance-sheet account change appears somewhere on the cash flow statement (e.g., CapEx affects PP&E, debt raises affect liabilities). These connections are what make the balance sheet balance after any change.

Depreciation is the cleanest example of a link across all three. On the income statement it's an expense that reduces net income. On the cash flow statement it's added back (it's non-cash). On the balance sheet it reduces net PP&E (via accumulated depreciation). So one depreciation entry touches all three statements. The same logic applies to stock-based compensation, deferred taxes, and amortization — they hit the income statement, get added back on the cash flow statement, and adjust a balance-sheet account.

Interviewers love: 'If depreciation goes up by $10, walk me through the three statements.' This tests whether you actually understand the links rather than memorizing them. The answer requires you to trace the $10 through pre-tax income, the tax effect, net income, the add-back, the cash change, and finally how the balance sheet stays balanced. (See the worked example below for the full trace.)

If you change anything correctly, the balance sheet stays balanced because every transaction has two effects. A $10 depreciation expense reduces an asset (PP&E by $10) but also reduces retained earnings — except the cash add-back and tax savings change cash too. The discipline of a three-statement model is that assets must always equal liabilities plus equity after every link is wired. If your model breaks the balance, you've missed a link — usually a cash flow statement line or a retained-earnings update.