Three-Statement Integration
Master the art of connecting the Income Statement, Cash Flow Statement, and Balance Sheet into a single, fully linked model. See how Net Income flows into cash, how CapEx and D&A roll through PP&E, and how working capital drivers affect both cash and balance sheet accounts.
Analyst Objective
Build a fully linked three-statement model where earnings, cash flow, and ending balances reconcile cleanly—and you can explain every link in an interview.
What You'll Learn
1Big-Picture Flow & Interview Tips
An integrated model is just a disciplined way to tell one story three times. The Income Statement measures performance, the Cash Flow Statement translates that performance into cash, and the Balance Sheet shows where that cash (and other resources) ended up. Integration is about making sure every dollar has a clear path from earnings to cash to ending balances.
Income Statement
Starts with Revenue, ends at Net Income. Provides D&A, interest, and tax expense inputs used across the model.
- COGS: ($600)
- OpEx: ($200)
- D&A: ($50)
= EBIT: $150
- Interest: ($20)
- Tax: ($39)
= NI: $91
Cash Flow Statement
Start with Net Income, adjusts for non-cash items and working capital, then overlays CapEx, debt, and equity flows.
+ D&A: $50
- ΔWC: ($10)
= CFO: $131
- CapEx: ($60)
= FCF: $71
+ Debt: $20
= ΔCash: $91
Balance Sheet
Receives the final story: Ending Cash, updated PP&E, debt, and Retained Earnings.
Cash: $191 ↑$91
PP&E: $410 ↑$10
Liability + Equity:
Debt: $220 ↑$20
RE: $381 ↑$91
The Integration Chain: How $1 of Revenue Flows Through
Revenue Hits the Income Statement
Company earns $1,000 in revenue → After all expenses (COGS, OpEx, D&A, Interest, Taxes) → Net Income = $91
Net Income Starts the CFS
That $91 Net Income flows to the top of CFO. But wait—accounting profit ≠ cash! Adjustments:
- Add back D&A ($50) because it's non-cash
- Subtract ΔWC ($10) because AR/Inventory tied up cash
- Result: CFO = $131
CapEx & Financing Complete the Picture
After CFO, we account for investments and financing:
- CapEx ($60) to buy equipment → shown in CFI
- New Debt ($20) borrowed → shown in CFF
- Net change: ΔCash = $91
Everything Lands on the Balance Sheet
All these flows update BS balances:
• Cash: $100 → $191 (+$91)
• PP&E: $400 → $410 (+$60 CapEx - $50 D&A)
• Debt: $200 → $220 (+$20)
• RE: $290 → $381 (+$91 NI)
Common Interview Questions on Integration
Q: "Walk me through how the three statements are connected."
A: "Net Income from the IS flows to the top of the CFS. After adjusting for non-cash items like D&A and changes in working capital, we get CFO. Adding investing activities (like CapEx) and financing activities (like debt issuance) gives us the change in cash. This change in cash flows to the Balance Sheet, where cash increases. Meanwhile, Net Income also flows to Retained Earnings on the BS, and CapEx flows through the PP&E schedule reducing net PP&E by D&A."
Q: "If Depreciation increases by $10, what happens to the three statements?"
A: "IS: Net Income decreases by $10 × (1 - Tax Rate), let's say $7 after-tax.CFS: We start with lower NI (-$7) but add back the full $10 in D&A, so CFO increases by $3.BS: Cash increases by $3, PP&E decreases by $10, and RE decreases by $7. Assets decrease by $7 total, matching the $7 decrease in equity."
Q: "Why do we add back Depreciation in the Cash Flow Statement?"
A: "D&A is an accounting expense that reduces Net Income on the IS, but no cash actually left the company—cash was spent when we bought the asset (CapEx). Since we start the CFS with Net Income, which already deducted D&A, we need to add it back to show that cash wasn't actually spent this period."
Common Integration Mistakes to Avoid
Integration mantra: IS → CFS (Net Income & non-cash items) → BS (Ending balances)
If a line appears on one statement, it should either feed into another statement or reconcile via a schedule. Every single number should have a clear, traceable path through all three statements.
See the Three Statements Connect in Real-Time
Watch how the three-statements dynamically link together. This animation shows the 8 key integration steps that make a fully connected financial model.
Step 1: Start: Income Statement
Revenue ($1,000) flows through expenses to calculate Net Income
Income Statement
2Retained Earnings & the Equity Bridge
Retained Earnings (RE) is where the Income Statement and Balance Sheet physically meet. It explains how much of cumulative Net Income has been kept in the business versus paid out as dividends.
Retained Earnings Roll-Forward
Net Income comes from the bottom of the IS. Dividends Paid comes from CFF on the CFS. The resulting REt ties to the Equity section of the BS.
Worked Example: RE Bridge
In your model, RE (2025E) must equal the Equity row labeled "Retained Earnings" on the 2025E Balance Sheet. If it doesn’t, the IS → CFS → BS chain is broken.
Equity Integration Tips
- Separate Paid-In Capital vs. Retained Earnings: New equity issuances change APIC; ongoing performance flows through RE.
- Dividends Link: Dividends Paid is a cash outflow in CFF and a reduction to RE in the roll-forward.
- Share Buybacks: Reduce cash (CFF) and typically reduce Treasury Stock / APIC, not RE directly, but they impact EPS through a lower share count.
3PP&E, CapEx, and D&A Roll-Forward
PP&E is where CapEx (CFI), D&A (IS & CFO), and sometimes asset sales (CFI) all collide. A clean roll-forward gives you auditability and keeps your integrated model from drifting out of balance.
PP&E Roll-Forward Formula
Where:
- CapEx is a negative CFI line (cash outflow).
- D&A is an expense on the IS and an add-back in CFO.
- Disposals reflect book value of assets sold; cash proceeds sit in CFI with gains/losses handled in CFO.
Worked Example: PP&E Integration
The PP&E (2025E) balance you compute here must exactly match the PP&E line on the 2025E Balance Sheet. If it doesn’t, check your CapEx sign convention and whether D&A ties to the IS.
PP&E Integration Best Practices
- Use a dedicated PP&E schedule: Never calculate PP&E balances directly on the Balance Sheet.
- Drive CapEx from revenue or capacity: Model CapEx as a % of revenue or via explicit project schedules.
- Lock D&A assumptions: Use straight-line lives for each asset class and aggregate into total D&A per year.
- Align book vs. cash: Remember: CapEx = cash; D&A = accounting. They rarely match year by year.
4Operating Working Capital in an Integrated Model
In Lesson 4 you modeled working capital inside CFO. In an integrated model, each ΔNWC line must also reconcile to the Balance Sheet and be driven by operational assumptions (DSO/DIO/DPO) that respond to changes in revenue and COGS.
Step 1: Forecast Balance Sheet Working Capital
Step 2: Translate to Cash Flow Statement
Any time you adjust DSO/DIO/DPO, you implicitly change the forecast AR/Inv/AP balances, which then feed into ΔNWC on the CFS. This is how policy changes (e.g., looser credit terms) show up as cash drag.
NWC Integration Tips
- Keep working capital on the Balance Sheet: The CFS should only reference year-over-year changes, never hardcoded amounts.
- Use average balances for ratios: For more realism, compute DSO/DIO/DPO based on average of beginning and ending balances.
- Watch sign conventions: When your BS looks right but CFO is off, sign mistakes in ΔNWC are usually to blame.
5Debt Schedule, Interest Expense, and Cash Movement
Debt is the bridge between the Balance Sheet, Income Statement, and Cash Flow Statement that introduces circularity. Interest expense depends on debt, but debt balances depend on cash available after interest.
Debt Roll-Forward
New Borrowings and Repayments show up in CFF on the CFS. The resulting Debtt equals the debt balance on the Balance Sheet.
Interest Expense Integration
Interest expense flows to the IS (within EBIT → EBT → Net Income). Cash interest paid appears in CFO. In more advanced models you can break out PIK vs. cash interest.
Circularity alert: Net Income depends on interest; interest depends on Average Debt; Debtt may depend on how much cash is available after Net Income and other uses. We handle this in Section 6.
6Understanding Circularity & Revolvers (Conceptual)
Entry-Level Note: Understand the Concept, Don't Build It Yet
This section is conceptual only and won't be tested in most entry-level interviews. However, understanding why it exists helps you debug models and sound knowledgeable when it comes up.
In sophisticated models, cash drives debt decisions. When a company runs low on cash, it draws from a credit line (revolver). When it has excess cash, it pays down that revolver. This creates a circular dependency: debt affects interest, interest affects Net Income, Net Income affects cash, and cash affects how much debt you need.
The Circularity Problem: A Chicken-and-Egg Situation
Interest depends on Debt balance: To calculate interest expense, you need to know how much debt the company has.
Net Income depends on Interest: Interest reduces EBIT → EBT → Net Income.
Cash depends on Net Income: Net Income flows through the CFS to ending cash.
Debt depends on Cash: If ending cash is too low, you need to borrow more. But that changes the debt balance, which brings us back to step 1!
🔄 This creates a circular loop: Debt → Interest → NI → Cash → Debt → ...
Simplified Example: Why We Need Circularity
Scenario: Company wants to maintain minimum cash of $20M
Without Circularity (Hardcoded Debt):
- Assume Debt = $100M → Interest = $5M
- Net Income after interest = $30M
- After CapEx and other uses, Ending Cash = $15M
- Problem: Cash is below $20M target, but model doesn't adjust debt automatically
With Circularity (Revolver Logic):
- Model sees Cash would be $15M (below $20M target)
- Automatically draws $5M from revolver → Debt increases to $105M
- This slightly increases interest to $5.25M
- Which slightly reduces Net Income to $29.75M
- Excel iterates until it converges: Ending Cash ≈ $20M, Debt ≈ $105M
If Asked in an Interview:
Q: "Do you know what circular references are in financial models?"
A: "Yes, they occur when values depend on each other in a loop. The most common example is when debt levels depend on cash balances, but interest on that debt affects how much cash you have. In practice, models use Excel's iterative calculation to solve this, often with revolver logic to maintain minimum cash balances. While I understand the concept, I'd be working with models where this is already built in at the start of my role."
7Building the Integrated Model Step-by-Step
Let's build a real integrated model for TechFlow Inc., a software company. We'll start with 2024 actuals and project 2025, showing exactly how each statement feeds into the next.
TechFlow Inc. - Starting Point (2024A)
Revenue
$500M
Cash
$50M
Debt
$200M
PP&E
$150M
Start with the Income Statement
Build revenue forecast and operating model first. This drives everything else.
Key Assumptions We'll Use:
Building 2025E Income Statement:
Build Cash Flow Statement (Start Simple)
Take Net Income from IS, add back D&A, then layer in working capital changes and investments.
Working Capital Assumptions:
First, Calculate Balance Sheet Items:
Now Build the CFS:
Create Supporting Schedules
Build PP&E and Debt schedules that tie to CFS flows.
PP&E Schedule:
Debt Schedule:
Complete the Balance Sheet
Everything flows here. Cash from CFS, PP&E from schedule, working capital from assumptions.
2024A
2025E
✓ Balance Sheet Balances! Assets ($430M) = Liabilities + Equity ($430M)
Watch the Full IS → CFS → BS Story in One Grid
This animation walks through the exact TechFlow Inc. example from this lesson. Each row shows how a single assumption or schedule flows across the Income Statement, Cash Flow Statement, and Balance Sheet until the model balances.
Start with Net Income
Net Income from the Income Statement is the anchor for both Cash From Operations and Retained Earnings.
8Core Integrity Checks & Error Flags
Integrated models are fragile. You’ll protect them with systematic checks that immediately highlight broken links. Many Ibleet validation rules later in the course are just automated versions of these.
Core Identity Checks
- 1. Total Assets = Total Liabilities + Equity
- 2. Ending Cash (CFS) = Cash Balance (BS)
- 3. ΔCash = CFO + CFI + CFF
- 4. REt = REt-1 + NI − Dividends
- 5. PP&E schedule = PP&E on BS
- 6. Debt schedule = Debt on BS
Error Flags & Visual Cues
Use a dedicated “Checks” row that turns bright red if any identity is off by more than a tiny tolerance (e.g., $0.01).
Create a “Model OK?” cell that displays “YES” when all checks pass and “NO” otherwise—just like a traffic light.
Flag negative cash, overdrawn revolvers, or debt balances below zero as separate warnings.
9Three-Statement Walkthrough Example
| Line | 2023A | 2024E | 2025E | Integration Notes |
|---|---|---|---|---|
| Revenue | 200 | 220 | 242 | Top-line driver for NWC, CapEx, and scale effects |
| EBIT | 40 | 46 | 52 | After D&A but before interest/taxes |
| Net Income | 26 | 30 | 34 | Flows into RE roll-forward & CFO |
| + D&A | 10 | 11 | 12 | Add-back; ties to PP&E schedule |
| ± ΔNWC | −3 | −4 | −5 | Derived from AR/Inv/AP on BS |
| CFO | 33 | 37 | 41 | = NI + non-cash + ΔNWC |
| − CapEx | −15 | −17 | −19 | Cash spend; drives PP&E |
| CFI | −15 | −17 | −19 | Assume no other investing items |
| + Net Borrowings | 2 | 0 | 0 | Debt schedule → CFF |
| − Dividends | −6 | −8 | −9 | Also used in RE roll-forward |
| CFF | −4 | −8 | −9 | Financing activities total |
| ΔCash | 14 | 12 | 13 | = CFO + CFI + CFF |
| Beginning Cash | 20 | 34 | 46 | Prior year ending |
| Ending Cash | 34 | 46 | 59 | Ties directly to BS cash line |
| RE (Start of Year) | 90 | 110 | 132 | From prior BS |
| RE (End of Year) | 110 | 132 | 157 | RE + NI − Dividends each year |
Insight: Notice how a single Net Income line influences both cash generation (CFO) and equity growth (RE). As you change margin, CapEx, or payout ratio assumptions in the model, this table is a great way to sanity check the story.
10Key Takeaways & Interview Prep
A three-statement model is just one story told three ways—performance (IS), cash (CFS), and position (BS).
Retained Earnings, PP&E, and Debt roll-forwards are the main highways linking statements together.
Working capital drivers (DSO/DIO/DPO) create realistic cash swings and connect growth to cash needs.
Debt, interest, and revolvers introduce circularity; manage it with clean schedules and controlled iteration.
Robust checks (BS balance, cash ties, RE/PP&E/debt reconciliations) turn a fragile model into a reliable one.