Financial Statements and Tax Returns are the foundation for understanding the financial condition of businesses and other economic entities. This foundation must be understood by anyone who is responsible for analyzing them to make a loan decision or manage credit risks posed by the lending function of the financial institution.

Economic events will typically start through an entry onto the Income Statement and the results of that event will find its way to the Balance Sheet. In other words, whatever occurs on the Income Statement will end up on the Balance Sheet. For example, if cash is not collected at the point of sales or an obligation is not settled at the point of incurrence, it will flow to the Balance Sheet either as an Asset, Liability or Net Worth Account. There are other economic activities that will be reflected on the balance sheet without first going through the income statement.

Understanding the relationship between the Balance Sheet and the Income Statement will enhance an analyst knowledge of why certain items from the Income Statement and the Balance Sheet are matched mathematically in a ratio calculation to determine a company’s liquidity, leverage, asset management capabilities and operating performance. It will also provide the secrets to understanding how a financial statement prepared on an Accrual basis is converted into a Cash basis financial statement to determine the amount of cash generated or used by an economic entity.