Financial statements: the three reports and how they connect

Financial statements are the standard set of reports that describe a business in numbers: what it earned over a period, what it owns and owes at a point in time, and how cash actually moved. Read individually they are easy to misinterpret. Read as a set, each one explains a gap the others leave, and that is the entire reason there are three rather than one.

The gap that catches people out is between profit and cash. A profitable quarter can end with less money in the bank than it started with, and a loss-making one can end with more. Nothing is wrong when that happens — it is what the third statement exists to explain.

What each of the financial statements tells you

• The income statement covers a period: revenue earned, costs incurred, profit left over. It follows the earning of money, not its arrival, which is why it can show profit you have not been paid.
• The balance sheet is a photograph of one day: assets on one side, liabilities and equity on the other, always equal. It answers what you own and what you owe right now, not how you got there.
• The cash flow statement reconciles the two: it starts from profit and adjusts for everything that moved money without touching profit, or touched profit without moving money.
• A statement of changes in equity, required in many regimes, tracks what happened to the owners' stake — profit retained, dividends paid, capital introduced.

How they connect

1. Profit from the income statement flows into retained earnings on the balance sheet. That single line is the join between the period and the moment.
2. The change in the bank balance between two balance sheets is exactly what the cash flow statement explains, line by line.
3. Money earned but not received sits in receivables — an asset on the balance sheet, revenue on the income statement, and nothing at all in cash.
4. Money spent on equipment barely touches the income statement in the year you spend it — it becomes an asset and is charged out slowly as depreciation — while the cash left immediately.
5. Depreciation itself is the reverse case: a cost with no payment, which is why it is added back at the top of the cash flow statement.

If you read only one, read the cash flow statement. Profit is the product of judgements about when revenue is earned and how costs are spread; cash movement is a fact you can check against the bank. That is not an argument for ignoring the income statement — it is why any serious reader looks at both and treats a growing gap between them as the thing to explain.

The questions each set should answer

• Is the business profitable, and is the margin moving? Income statement, compared across periods rather than read alone.
• Could it survive a slow quarter? Balance sheet: current assets against current liabilities.
• Is growth being funded by customers or by borrowing? Cash flow statement, split between operating, investing and financing.
• Is profit turning into cash? Compare operating cash flow with profit over several periods. A persistent gap is either a receivables problem or an accounting policy worth questioning.

Producing them

Ettex Books keeps the ledger these reports are drawn from and produces the standard statements from it, provided the underlying entries are right — which is the actual work, and why the mechanics of double entry are worth understanding. Supporting detail lives where it is created: unpaid customer invoices in Ettex Invoices, working calculations in Ettex Sheets.

Two limits, stated plainly. Ettex Books is not audited or certified accounting software for every jurisdiction, and it does not file anything: statutory accounts and returns go through your accountant or your local filing system. Nor does it apply the presentation rules of a specific standard — how a set of accounts must be laid out under IFRS or a national GAAP is a question for a qualified accountant in your country.

Two judgements sit behind the numbers rather than in them. Revenue recognition decides which period a sale lands in, and going concern decides whether the accounts can be prepared on the ordinary basis at all. Both are directors’ decisions, both are documented separately, and both are the first things an auditor asks about.

Where the company has subsidiaries, these are not the only statements that matter. Consolidated accounts present the group as a single entity, with everything the group did with itself eliminated — and a lender or buyer will normally ask for those rather than the parent’s own figures.

Two judgements decide what the statements say. Going concern determines whether they can be prepared on the ordinary basis at all, and consolidated accounts are what a group must present instead of the parent’s own figures.