# Three Statement

> Balance sheet, income statement, and cash flow statement integrity - the balance check, indirect cash flow tie to balance-sheet deltas, retained-earnings roll-forward, working-capital linkages, and the standard breakpoints where a three-statement model or a reported set of financials stops articulating. Use when building, reviewing, or debugging financial statements or a three-statement model, and whenever the statements must foot before anything downstream uses them. Trigger on "balance sheet", "income statement", "P&L", "cash flow statement", "doesn't balance", "three-statement", "statements don't tie", "retained earnings", "working capital".

- Skill: `lukehle/three-statement` (Agent Skill)
- Install (CLI): `npx skillmds@latest add lukehle/three-statement`
- Raw SKILL.md: https://api.skillmd.com/api/skills/lukehle/three-statement/raw
- Safety review: pending
- Works with: Claude Code, Claude.ai, OpenAI Codex
- Category: AI & ML
- Author: Lukehle (https://skillmd.com/u/lukehle)
- Updated: 2026-09-17
- Page: https://skillmd.com/skills/lukehle/three-statement

---


# Three-statement integrity

The three statements are one system, not three reports. Every figure on the cash flow statement is
derived from a change on the balance sheet or a line on the income statement. When they stop
articulating, the break is always locatable — this skill is the search order.

Load `tie-out` first. Every check below emits a PASS/FAIL with a stated threshold.

---

## The four structural checks

Run these in order. Do not proceed past a FAIL — a downstream check on broken inputs produces
misleading results.

### 1. The balance check

```
Assets = Liabilities + Equity        (both periods, exactly)
```

Threshold: **exact.** Not "within rounding." If your system carries cents, it balances to the cent.
An out-of-balance balance sheet is never a materiality question.

### 2. Retained earnings roll-forward

```
Opening RE + Net income - Dividends/distributions +/- Prior-period adjustments = Closing RE
```

The `Net income` in this roll **must equal** the bottom line of the income statement for the same
period. This single check catches most statement-linkage errors, because it is where the income
statement physically connects to the balance sheet.

If it fails, the usual causes are: an equity entry booked directly to RE without flowing through the
P&L, an OCI item misclassified into RE, or a period-boundary mismatch.

### 3. Cash flow ties to the balance sheet

```
Net change in cash (per CF statement) = Closing cash (BS) - Opening cash (BS)
```

Threshold: **exact.** Include restricted cash and cash equivalents consistently on both sides — a
mismatch here is very often a definitional inconsistency rather than an arithmetic error.

### 4. Indirect cash flow reconstructs from BS deltas

Every line in the operating and investing sections traces to a balance-sheet movement:

```
Cash from operations
  Net income                              <- IS bottom line (same figure as check 2)
  + Depreciation & amortization           <- accumulated D&A delta (+ disposals)
  + Stock-based compensation              <- APIC delta attributable to SBC
  +/- Deferred taxes                      <- deferred tax asset/liability delta
  - Increase in AR                        <- -(closing AR - opening AR), gross of bad debt
  - Increase in prepaid                   <- -(closing - opening)
  + Increase in AP                        <- +(closing - opening)
  + Increase in accrued liabilities       <- +(closing - opening)
  + Increase in deferred revenue          <- +(closing - opening)  <-- the SaaS one
```

Working-capital sign convention, which is where people slip: **an asset increase is a cash outflow;
a liability increase is a cash inflow.** Deferred revenue rising is cash *in* — for a SaaS company
this is often the largest single operating cash item and the reason a business can be
loss-making and cash-generative simultaneously.

---

## The standard breakpoints

When statements do not articulate, check these in this order. This ordering reflects frequency.

| # | Breakpoint | Symptom | Test |
|---|---|---|---|
| 1 | **Non-cash item omitted from CF** | CF change ≠ BS cash change | Sum SBC, D&A, impairments, non-cash lease expense; confirm each appears |
| 2 | **Working-capital sign error** | CF off by exactly 2× a WC delta | Recompute each WC line; a 2× error is always a sign flip |
| 3 | **Gross vs net movement** | BS delta ≠ CF line for AR or fixed assets | AR delta must be gross of the bad-debt provision; PP&E needs additions and disposals separately, not net |
| 4 | **Acquisition/disposal balances** | Assets jump with no cash line | An acquisition adds balances without operating cash flow — must sit in investing, and the acquired working capital must be excluded from operating |
| 5 | **FX translation** | Small persistent unexplained residual | CTA is not a cash flow. It gets its own reconciling line; it never nets into operating |
| 6 | **Period boundary** | Closing ≠ next opening | The prior period was restated, or the model pulls opening from the wrong column |
| 7 | **Circular reference** | Interest depends on debt depends on cash depends on interest | Break it: compute interest on the *opening* or average balance, or use a documented iterative switch |
| 8 | **Plug** | It balances but you cannot say why | Someone added a plug. Find it and delete it |

**On plugs:** a plug is not a fix, it is a concealment. If a model contains a balancing plug, the
correct action is to locate the real break and remove the plug — and to note in the review that
results produced while the plug existed are unreliable.

---

## Reviewing a three-statement model

Beyond the arithmetic, check the construction:

- [ ] **One input cell per assumption.** An assumption entered in two places will disagree.
- [ ] **No hardcodes inside formula rows.** A typed constant in a calculated row is the single most
      common model defect — see `model-audit` for the mechanical detection.
- [ ] **Consistent formulas across a row.** A row where column K differs structurally from J is
      almost always an error, not an intentional exception.
- [ ] **Sign conventions declared and consistent.** Expenses positive-and-subtracted, or
      negative-and-added — pick one, state it, never mix within a statement.
- [ ] **Historicals locked.** Actuals should not be formula-driven off assumptions.
- [ ] **Circularity handled explicitly.** Either broken by design or controlled with a documented
      iterative switch and a convergence check. Never left implicit.
- [ ] **The balance check is visible on the sheet**, not buried. If a model does not show its own
      balance check, add one before doing anything else with it.

---

## SaaS-specific statement notes

- **Deferred revenue is the pivot.** It links billings (cash) to revenue (ASC 606). Reconciling it is
  simultaneously a balance-sheet control and the bridge between dashboard ARR and GL revenue — see
  `saas-metrics` and the deferred-revenue section of `reconciliation`.
- **Capitalized commissions (ASC 340-40)** sit as a contract asset amortized over the expected
  benefit period. They depress cash relative to P&L in a growth period; the amortization is a
  non-cash add-back.
- **Capitalized software** moves engineering cost from opex to an intangible with its own
  amortization. It flatters EBITDA. When reporting a Rule of 40 or a burn multiple, state whether
  capitalization is included — it materially changes the answer, and comparability with benchmarks
  depends on it.
- **SBC is the largest non-cash item** at most venture-backed SaaS companies. Every EBITDA-style
  metric must state whether it is before or after SBC.

---

## Multi-entity and FX translation (ASC 830)

The moment a foreign subsidiary appears, the single-entity checks above are necessary but no
longer sufficient. The procedure, in order:

1. **Determine each entity's functional currency first** — the currency of the primary economic
   environment (where it prices, pays, and holds cash), not the currency it happens to report in.
   This decision picks the method for everything below, and changing it later is a restatement,
   not a toggle.
2. **Pick the method the determination dictates:**
   - Functional currency = local currency → **current-rate translation**: assets and liabilities
     at the period-end rate, income statement at the average rate (or transaction-date rates),
     equity at historical rates. The plug lands in **CTA, inside OCI/equity — never in net income**.
   - Functional currency = the parent's currency → **remeasurement**: monetary items at the
     period-end rate, non-monetary items at historical rates, and the gain/loss runs **through the
     income statement**. Translating a subsidiary the wrong way silently moves FX out of (or into)
     earnings.
3. **Roll the CTA forward like any other equity account**: opening CTA + current-period translation
   adjustment = closing CTA, and the movement must reconcile to the rate changes applied — a CTA
   that moved with no rate story is a plug hiding an error. This is the account the Output block's
   OCI line exists for; "single-entity, no foreign subsidiaries this period" is the honest note
   when it is empty, not a default to leave unexamined.
4. **Eliminate intercompany before consolidating, in one currency.** Intercompany balances must
   net to zero *after* both sides are translated — a payable booked at one month's rate against a
   receivable at another's leaves a phantom difference that belongs in CTA (or FX gain/loss under
   remeasurement), not in a consolidated asset. The matching mechanics live in `reconciliation`'s
   intercompany rules; this check is where they meet the statements.
5. **Rates are inputs, pinned as-of** — loaded at Phase 0 with the trial balances, with the source
   and date stated, per the as-of principle. A rate fetched live mid-close is unauditable; a rate
   loaded with the extract ties out forever.

Scope note: this is the close-mechanics layer — enough to translate, roll CTA, and prove the
eliminations. Full consolidation systems (ownership ladders, minority interest, hyperinflationary
economies under ASC 830-10) are out of this pack's scope, per the README boundary.

---

## Output

```
STATEMENT INTEGRITY | period 2026-07 | as-of 2026-08-19T14:20Z

1. Balance check          A 48,220,115.02 = L+E 48,220,115.02        PASS (exact)
2. RE roll-forward        11,204,880 + (1,412,004) - 0 = 9,792,876   PASS
   NI per roll (1,412,004) = IS net income (1,412,004)               PASS
3. CF ties to BS cash     net change (884,120) = 6,110,447-6,994,567 PASS (exact)
4. Indirect CF rebuild    all 9 lines trace to BS deltas             PASS
                          largest: deferred revenue +1,209,880

NOT CHECKED
  - OCI/CTA detail: single-entity, no foreign subsidiaries this period
  - Segment statements: not prepared

RESULT  PASS
```

---

## Degraded mode

Every check here is arithmetic on figures you can read off the statements. No tooling required. With
a spreadsheet available, build the four checks as visible formulas on the sheet so they re-run
themselves — a check that lives only in a chat transcript does not protect next month's close.

---

## Related skills

- `tie-out` — the output format
- `reconciliation` — the account-level proofs feeding the statements
- `model-audit` — mechanical detection of the construction defects listed above
- `saas-metrics` — where statement figures meet operating metrics
- `flux-analysis` — explaining the movements once the statements foot