How are the balance sheet and the cash flow statement linked?

• A. Beginning cash comes from the previous period's balance sheet; cash from operations is affected by changes in working capital; depreciation from PPE affects cash from operations; ending cash is the cash balance on the new balance sheet.
• B. Beginning cash is independent of prior balances; operating cash flow is unaffected by working capital; depreciation does not affect cash flow; ending cash equals net income.
• C. Beginning cash is taken from current assets only; depreciation affects financing activities; ending cash is the same as beginning cash.
• D. Beginning cash comes from the income statement; cash from operations depends only on net income; ending cash is not related to the balance sheet.

Answer: (A)

The link between the balance sheet and the cash flow statement is that they reflect the same pieces of a company’s finances from different angles over the period. The cash flow statement shows how cash changed from the beginning to the end of the period, and the balance sheet shows the cash balance at those two points in time. Specifically, the starting point on the cash flow statement is the cash balance from the previous period’s balance sheet, and the ending point must equal the cash balance reported on the current period’s balance sheet. Cash from operations is driven by net income but is adjusted for non-cash items and for changes in working capital, so depreciation—an expense that reduces net income but does not actually use cash—is added back in, and changes in current assets and current liabilities (working capital) also move cash up or down. Depreciation ties to PPE on the balance sheet as a non-cash expense and as accumulated depreciation reduces the net book value of PPE over time, influencing both the income statement and the balance sheet while showing up in cash from operations. In short, beginning cash comes from the prior period’s balance sheet, cash from operations reflects adjustments for working capital and non-cash items like depreciation, and ending cash must match the cash balance on the new balance sheet.