The Three Statements and How They Connect
What the profit and loss account, balance sheet and cash flow statement each show, and the links that make them one system.
12 min
Activities: 0 of 2
Three views of one business
A complete financial model produces three statements. Each answers a different question, and together they describe the business without gaps.
- Profit and loss account (also called the income statement) — Did we earn more than we spent over this period? Revenue, minus cost of sales, gives gross profit; minus operating costs gives operating profit.
- Balance sheet — What do we own and owe at this moment? Assets (cash, receivables, inventory, equipment) equal liabilities (amounts owed to others) plus equity (the owners' share).
- Cash flow statement — Where did the cash come from and where did it go? Split into operating, investing and financing activities.
Many founders build only a profit and loss forecast. It shows whether the business makes a profit, but not whether it has the cash to survive while getting there — which, as the course has already stressed, is the number that kills companies.
How the statements link each month
- 1
Link 1
Profit flows into equity
The profit (or loss) for the month is added to retained earnings, part of equity on the balance sheet. - 2
Link 2
Profit is the start of operating cash flow
The cash flow statement starts from profit, then adjusts for items that are not cash, such as depreciation. - 3
Link 3
Working capital changes adjust cash
If receivables rise, cash collected is less than revenue, so cash flow is reduced by the increase. - 4
Link 4
Closing cash goes to the balance sheet
Opening cash plus net cash flow equals closing cash, which must match the cash line on the balance sheet.
Worked example: one month
A small company starts the month with 50,000 in cash. During the month it invoices customers 40,000, of which customers pay 25,000 before month end. It pays 30,000 in salaries and costs. It buys a laptop for 2,400 that will be used for 24 months, so depreciation is 100 a month.
| Statement | Result |
|---|---|
| Profit and loss | Revenue 40,000 − costs 30,000 − depreciation 100 = profit 9,900 |
| Cash flow | Profit 9,900 + depreciation 100 − increase in receivables 15,000 − laptop 2,400 = net cash flow −7,400 |
| Balance sheet | Cash 42,600; receivables 15,000; laptop 2,300 (after one month); retained earnings up 9,900 |
The company made a profit of almost 10,000 and still has 7,400 less cash than at the start. All three statements are correct. Only together do they show the full picture.
Second example: a profitable month with a cash crisis
A contractor wins a 300,000 project. In month one it buys 120,000 of materials, paid immediately, and pays 60,000 of wages. The client pays 30% on signing and the rest on completion in month four. The profit and loss for the whole project shows a healthy margin. But the cash flow in month one is 90,000 in (30% of 300,000) and 180,000 out. Without the cash flow statement, the contractor would not see the 90,000 gap until wages bounced.
A company makes a profit of 20,000 in a month, but receivables increase by 35,000. Ignoring other items, what happens to cash?
Match the statement to its question
- Profit and loss account
- Balance sheet
- Cash flow statement