Describe how net income affects the three primary financial statements.

• A. Net income from the income statement is irrelevant for the cash flow statement
• B. Net income from the income statement affects equity and retained earnings and drives cash flow from operations
• C. Depreciation has no link to other statements
• D. The balance sheet is independent of the income statement

Answer: (B)

Net income shows how profitable the period was and ties the income statement to the balance sheet through retained earnings. When the company earns net income, that amount increases retained earnings, which are part of shareholders’ equity on the balance sheet. Over time, this accumulating profit boosts total equity unless dividends reduce retained earnings. On the cash flow statement, operating cash flow typically starts with net income (especially in the indirect method) and then adjusts for non-cash items like depreciation and amortization and for changes in working capital. These adjustments convert accrual net income into cash, illustrating how profitability flows into actual cash generation. So net income links the three statements by boosting equity via retained earnings and by serving as the starting point for cash from operations, with non-cash expenses and changes in working capital bridging the gap to cash.