The three financial statements are how a business reports its performance and position. Being able to read and explain them is what separates a confident finance professional from a data-entry clerk. Employers test this constantly.
1. Profit & Loss (Income Statement)
Shows performance over a period (e.g. a year): did the business make a profit?
- Revenue (sales) − Cost of sales = Gross profit
- Gross profit − Operating expenses = Operating profit
- Operating profit − interest − tax = Net profit (the "bottom line")
Key idea: it's prepared on an accruals basis — it shows income earned and costs incurred, not cash moved.
2. Balance Sheet (Statement of Financial Position)
A snapshot at a point in time of what the business owns and owes:
Assets = Liabilities + Equity
- Non-current assets (long-term: property, equipment) and current assets (short-term: stock, debtors, cash).
- Current liabilities (due within a year: creditors, tax) and non-current liabilities (long-term loans).
- Equity — capital + retained earnings.
3. Cash Flow Statement
Shows how cash actually moved over the period, split into:
- Operating activities (day-to-day trading),
- Investing activities (buying/selling assets),
- Financing activities (loans, share issues, dividends).
Why profit ≠ cash (the crucial insight)
A business can be profitable but run out of cash (e.g. it made sales on credit that customers haven't paid yet, or bought lots of stock). This is why all three statements matter — and why cash flow kills more businesses than lack of profit. Being able to explain this is a favourite interview question.
How the statements connect
- Net profit from the P&L increases retained earnings (equity) on the balance sheet.
- The cash figure on the balance sheet is explained by the cash flow statement.
- The statements are three views of the same reality — performance, position, and liquidity.
Put it to work
For a business that made a £50k profit but saw cash fall, list two reasons that could happen. Then explore management accounts & budgeting.