The Three-Statement Model
How the income statement, balance sheet, and cash flow statement link into one living model — and the circularity traps that break it.
The three-statement model is the backbone of every valuation. Get the links right and everything downstream — DCF, LBO, comps — stands on solid ground.
The three statements
- Income Statement — profitability over a period.
- Balance Sheet — what you own and owe at a point in time.
- Cash Flow Statement — the bridge that reconciles the two.
The links that matter
Net income flows from the income statement into retained earnings on the balance sheet and into the top of the cash flow statement. Ending cash on the cash flow statement becomes the cash line on the balance sheet.
Net Income → Retained Earnings (BS)
Net Income → CFO (CFS) → Δ Cash → Cash (BS)
The circularity trap
Interest expense depends on debt, debt depends on the cash sweep, and the cash sweep depends on... interest expense. This circular reference is normal — enable iterative calculation, but always keep a circuit breaker switch so you can kill the loop when the model errors.