How is the income statement really linked to the balance sheet? I don't get it
Everybody says net income flows into retained earnings. I get that.
But what I don't get is when I assess the individual transactions during the year "i.e., walk me through the effect of depreciation ..." - why does depreciation reduce retained earnings when all of this is PRE income tax?
Do we just hypotehtically state that "a depreciation of 10 reduces retained earnings by 10"? because in reality I would calculate net income and book the net income (after tax) against retained earnings, correct?
You have to be kidding me…
I would hate to give a long winded answer but you kinda have to know this like the back of your hand mate.
Here is the deal, while depreciation is Pre-tax, it imapcts your post-tax NI. NI will flow to retain earning as well as the first line item in your cfs. D&A will also be added back into your D&A thus that will impact your ending cash balance. Cash is a plug from the CFS.
Note, increase in depreciation means decrease in Pp&e. At the end of the rundown, your Asset (change in cash and Pp&E) will equal your L&E (change in RE)
Please let me know which part is confusing, happy to dive deeper.
Just give up on banking bro
If depreciation reduces by $10, net income goes up $7 (assuming 30% tax rate).
Net income flows to the top of the cash flow statement. CFO (ignoring CFF and CFI) starts up $7, but the $10 decrease in depreciation takes net cash change down to -$3.
On the BS, PP&E will be raised $10, cash is down $3, totaling $7 increase in assets. The net income (ignoring dividends) flows into retaining earnings, so equity is up $7, and both sides balance.
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