Three-Statement Build Example: Revenue to Change in Cash
The three statements aren't three separate models — they're one build. Start with revenue, work the income statement down to net income, then let that number carry you through the cash flow statement to the change in cash.
Why this matters
One build, three statements, one thread of cash
A three-statement model links the income statement, cash flow statement, and balance sheet so that a change in one flows correctly through the others. The single most important thread is cash: the income statement tells you what you earned, and the cash flow statement translates that into what actually landed in the bank. The connection runs in a specific direction — income statement → cash flow → cash on the balance sheet — and getting that order right is the whole exercise.
This is why a modeling test almost always starts you at the top with revenue and a margin and asks you to build down. You produce net income on the income statement, then hand it to the cash flow statement, which strips out the non-cash items and layers in the cash costs the income statement ignored — the working-capital swing and capital expenditures. What comes out the bottom is the change in cash for the year, and that number posts straight to the balance sheet.
This guide walks one clean example end to end — every line, with the intuition behind each adjustment — and then hands you a graded drill so the sequence becomes automatic under a timer.
Worked example
From $1,000M of revenue to a +$38M change in cash
The inputs
- Revenue$1,000M
- EBITDA margin20%
- Depreciation & amortization (D&A)$50M
- Interest expense$20M
- Tax rate40%
- Capital expenditures (capex)$60M
- Increase in net working capital$30M
Step 1 — Build the income statement to net income
Start at revenue and apply the margin to get EBITDA, then step down through D&A, interest, and tax. Each line strips out one more cost:
EBIT = 200 − 50 (D&A) = $150M
Pretax = 150 − 20 (interest) = $130M
Net income = 130 × (1 − 40%) = $78M
Notice how far net income sits below EBIT: $150M of operating income becomes just $78M once the capital structure (interest) and the tax authority take their cut.
Step 2 — Roll net income into cash flow from operations
The cash flow statement begins with net income and reverses the accounting that didn't move cash. Add back the D&A (a non-cash expense), then subtract the increase in net working capital (cash tied up in the business):
CFO = 78 + 50 − 30 = $98M
The $50M add-back alone lifts net income of $78M to $128M of cash; the $30M working-capital build then pulls it back to $98M of operating cash.
Step 3 — Subtract capex to get the change in cash
The last piece is capital expenditure — cash spent buying long-lived assets, which lives in the investing section rather than the income statement:
Change in cash = 98 − 60 = +$38M
Operating cash of $98M more than covered the $60M capital program, so the cash balance rose by $38M. That +$38M posts to the balance sheet: cash goes up $38M on the asset side, and retained earnings rises by the $78M of net income on the equity side — the two statements meet on the balance sheet.
The intuition
Why the adjustments go the way they do
Net income is an accrual number: it records revenue when earned and expenses when incurred, regardless of when cash changes hands. The cash flow statement exists to bridge that gap, and every adjustment does one of two jobs — undo a non-cash expense, or capture a cash movement the income statement never saw.
D&A is the textbook non-cash expense. The cash left the business when the asset was purchased; spreading that cost over the asset's life reduces net income in every later year without any new cash going out. Because the cash flow statement starts from net income, you add D&A back to reverse a deduction that never touched cash. In the example, that add-back is the single biggest adjustment — $50M on $78M of net income.
The working-capital swing and capex go the other way — they are real cash movements the income statement ignores. An increase in net working capital means you have shipped product or booked revenue but not yet collected the cash, or you are holding more inventory: cash is tied up, so you subtract it. Capex buys assets that will be expensed slowly via future D&A, so only a sliver hits this year's income statement even though the full amount leaves the bank now. Both are cash drains, which is exactly why a profitable company can still see its cash balance fall in a heavy-investment year.
Watch out
Common mistakes
Forgetting the D&A add-back
The most frequent slip is starting the cash flow statement from net income and then failing to add D&A back — or worse, subtracting it again. D&A was already taken out on the income statement; leaving it out of the cash flow build understates operating cash by the full amount. Here, skipping the $50M add-back would report CFO as $48M instead of $98M and flip the change in cash to a false −$12M.
Sign errors on net working capital
An increase in net working capital uses cash, so it is subtracted; a decrease releases cash and is added. Flipping the sign is easy under pressure because the income statement gives no hint of the direction. Adding the $30M instead of subtracting it would overstate CFO by $60M — a two-for-one error that wrecks every line below it.
Confusing EBIT and net income
EBIT ($150M here) sits above interest and tax; net income ($78M) sits below both. Rolling EBIT into the cash flow statement — or quoting it as the "bottom line" — double-counts cash you never had, since interest and tax are genuine cash costs. The cash flow build must start from net income, the true after-financing, after-tax figure.
Treating a negative change in cash as an error
If capex and the working-capital build had outrun operating cash, the change in cash would be negative — and that is a perfectly valid answer, not a mistake to "fix." A growing company routinely burns cash while it invests, funding the gap from its balance sheet or new financing. Chase the arithmetic, not a positive sign.
FAQ
Frequently asked questions
How do the three statements connect in a build?
The income statement produces net income by working from revenue down through EBITDA, EBIT, interest, and tax. Net income is the first line of the cash flow statement, which adjusts it back to actual cash: add back non-cash D&A, subtract the increase in net working capital to get cash flow from operations, then subtract capex to get the change in cash. That change in cash flows onto the balance sheet, updating the cash balance while retained earnings absorbs net income — so all three tie.
Why do you add D&A back on the cash flow statement?
Depreciation and amortization are real expenses that reduce net income, but no cash leaves the business when you record them — the cash went out earlier when the asset was bought. Since the cash flow statement starts from net income, you add D&A back to undo a deduction that never touched cash. In the worked example, net income of $78M becomes $128M of operating cash before working-capital and capex effects, purely from adding back the $50M of D&A.
Why are capex and an increase in net working capital cash drains?
Both consume cash that never appears as an expense on the income statement. Capex buys long-lived assets, so it hits the investing section, not the income statement. An increase in net working capital means more cash is tied up in receivables and inventory than is financed by payables — cash you have earned but not yet collected. In the example, the $30M working-capital build and $60M of capex together pull $90M out, turning $128M into a +$38M change in cash.
What is the difference between EBIT and net income?
EBIT (operating income) is earnings before interest and tax — it sits above the capital structure and the tax line. Net income is what remains after subtracting interest expense and taxes. In the worked example EBIT is $150M, but after $20M of interest and 40% tax, net income is only $78M. Confusing the two is a classic error: EBIT flows into a DCF or an EV/EBIT comp, while net income is what drives EPS and starts the cash flow statement.
Is a negative change in cash a mistake?
No. A negative change in cash just means the company spent more on operations plus capex than it generated that year, so its cash balance fell. That is common and healthy for companies in a heavy-investment phase — the shortfall is funded from an existing cash pile or new financing. The build is about arithmetic accuracy, not producing a positive number; a $38M increase and a $22M decrease are equally valid outputs depending on the drivers.
Now build it under a timer
Reading the walkthrough is one thing — constructing it line by line against the clock is another. Run the graded three-statement build with fresh drivers every attempt, or assemble the full linked model with live data.
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