LOS E requires us to:
describe how the cash flow statement is linked to the income statement and the balance sheet.
a. The most primary relationship described in the cash from operations is the value of ‘change in cash.
i. It can be calculated using the following equation:
ii. Another way of finding the value of change in cash is:
iii. Thus, combining both the equations we get:
b. Another important thing worth noting is that all the transactions for which the timings of the expense or revenue differ from the timings of receipt or payment of cash get reflected in the balance sheet. For example, due to sales being made on credit (resulting in the difference in the timing of sale and receipt), another account for sundry debtors gets created, and the same is reflected in the current asset section of the balance sheet.
c. Thus, it is important to understand the relation between the credit sales, cash receipts, and the balances in the accounts receivable account. This is reflected in the following equation:
d. Similarly, the relation between the accounts payable and purchases can be understood using the following equation:
e. We can also deduce the equation in a similar fashion for the retained earnings and dividends. The required equation is:
It is extremely important to understand these accounting equations, as these will not only help in understanding the financial statements but will also help in understanding the basics of accounting.