I received a question via Twitter that I am going to answer here. Matthew Griffith asked me to expand point #2. Here goes:

One dollar of capital raised on the liabilities side of the balance sheet becomes a dollar of assets, also on the balance sheet. Then it hops to the income statement and makes its way down to profits as each constituent with a claim to the business gets paid: customers receive a product (i.e. cost of goods sold), employees get paid, advertisers get paid, the research department gets paid, then debt holders get paid, then tax and regulatory authorities, then shareholders. Anything leftover makes its way back to the liabilities side of the balance sheet as retained earnings.

Next, the cash flow statements accounts are the net changes of balance sheet accounts, roughly speaking. In practice it never quite is exactly the same. For example, the net change in receivables on the balance sheet ought to be represented in the operating cash flow portion of the cash flow statement. If there is a huge disparity this is reason to talk with management.

Each of the statements serves as a check and balance on the other and an understanding of this reflexivity helps you to understand: a) the mechanics of the business itself, that is, how they make their money; b) the culture of the company's finance and accounting function, which is more obvious when compared with a firm's competition; and c) if fraud or a big stretching of the truth is taking place.

I hope this helps.

Yours, in service,

Jason