Financial statement linkages
Why a balance sheet should always balance – net assets increase by retained earnings
In the previous example, profits and retained earnings increased by 100. Our store of value/ the tank has increased by 100. Net assets on the balance sheet have increased by the 100 retained earnings.
Changes to other balance sheet items
On the balance sheet, cash balances increase by the 75 cash flow. At the same time, debtors/ receivables (= the amount owed to us by customers) increases by 25. The Δ change in 100 net assets = the Δ change in cash plus the Δ change in other balance sheet items. The balance sheet always balances!
On the cash flow statement:
- Δ cash = Δ profits + Δ other BS items (75 = 100 – 25)
I.E. all cash flow movements can be expressed as profits (100) plus the balance sheet changes in what we owe/ own (-25).
On the balance sheet:
- Δ profits/ net assets = Δ cash + Δ other BS items items (100 = 75 + 25)
I.E. all balance sheet movements (75 + 25) should match the increase in net assets arising from profits for the year (100).
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