Key Financial Statements for Business Accounting in the UK: Understanding the Balance Sheet, Income Statement, and Cash Flow Statement

What are the Three Financial Statements?

The three financial statements are:

(1) income statement

(2) balance sheet

(3) statement of cash flows.

Each financial statement provides important financial information to the internal and external stakeholders of a business.

The income statement illustrates a company’s profits under accrual accounting rules. The balance sheet shows the assets, liabilities, and equity of a company at a given point in time. The statement of cash flows shows cash flows from operating, investing, and financing activities.

These three basic commands stick together, and this tutorial will explain how they fit together. By following the steps below, you should be able to bind the three statements yourself.

Overview of the three financial statements

1. Income statement

Usually, the first place an investor or analyst looks is the income statement. The income statement shows the performance of the business for each period, showing revenue at the top. The report then deducts cost of goods sold (cost of goods sold) to find gross profit.

Since then, gross profit is affected by operating expenses and other income, depending on the nature of Business Accounting activities, to achieve the lowest net income – “bottom line” of the business.

Main features:
  1. Show income and expenses of a business
  2. Shown over a period of time (ie 1 year, 1 quarter, year-to-date, etc.)
  3. Use accounting principles such as matching liabilities and accruals to present numbers (not presented on a cash basis)
  4. Used to assess profitability
2. Balance sheet

The balance sheet shows the assets, liabilities, and equity of the business at a given point in time. The two sides of the balance sheet must balance each other:

assets must equal liabilities plus equity. The assets section begins with cash and cash equivalents, equivalent to the balance found at the end of the cash flow statement.

The balance sheet will then show the closing balance of each major account for each period. Net income from the income statement is included in the balance sheet as a change in retained earnings (adjusted for dividend payments).

Main features:
  1. Show the financial position of a company.
  2. Presented as a “snapshot” or financial picture of the business at a specific point in time (ie 31 December 2017)
There are three parts:

assets, liabilities and equity

Assets = Liabilities + Equity  

  1. Cash Flow Statement

The cash flow statement then takes the net income and adjusts it for all non-cash expenses. Then, cash inflows and outflows are calculated using changes in the balance sheet. The cash flow table shows the change in cash each period, as well as the opening and closing cash balances.

Main features:
  1. Show increase or decrease in cash
  2. Shown over a period of time (ie 1 year, 1 quarter, year-to-date, etc.)
  3. Override accrual accounting principles to show pure cash flow.
  4. There are three parts:

cash flow from operating activities, cash flow from investing activities and cash flow from financing activities

How are these 3 basic statements used in financial modeling? Each of the three financial statements presents an interaction of information. Financial models use trends in the relationships between the information in these reports, as well as trends between periods in historical data to predict future performance.

Preparing and presenting this information can get quite complicated. In general, however, the following steps are taken to create a financial model.

  1. Line items for each underlying declaration are created. It provides the general format and framework that the financial model will follow.
  2. History number placed in each line item
  3. At this stage, the modeler checks regularly to ensure that each base statement matches the data of the other. For example, the closing cash balance calculated in the cash flow statement should equal the cash account on the balance sheet.
  4. Assumptions are made in the sheet to analyze the trend of each line item of basic claims between periods
  5. Current historical data assumptions are then used to generate forecast assumptions for similar locations.
  6. The forecast portion of each underlying statement will use forecasting assumptions to populate values ​​for each line item. Since the analyst or user analyzed past trends when creating forecasting assumptions, the values ​​provided must follow historical trends.
  7. Schedule support is used to calculate more complex line items. For example, a debt calendar is used to calculate interest expenses and the balance of debts. The depreciation schedule is used to calculate depreciation expense and long-term fixed asset balance.
These values ​​will be found in three main statements
  1. How to read a balance sheet

The balance sheet reflects the “book value” of a business. It allows you to see what resources it has and how they are funded on a particular day. It shows assets, liabilities and equity (basically what it owes, owns and the amount invested by the shareholders).

The balance sheet also provides information that can be used to calculate rates of return and evaluate capital structure, using the accounting equation:

Assets = Liabilities + Equity. An asset is anything that a business owns with quantifiable value.

Liabilities are money that a business owes a debtor, such as unpaid payroll expenses, debt payments, rent and utilities, bonds payable, and taxes.

Equity refers to the net worth of a business. That’s the amount that would be left if all assets were sold and all debts paid off. This money belongs to the shareholders, who can be private owners or public investors. A balance sheet alone doesn’t provide trending information, which is why you need to look at other financial statements, including the statement of income and cash flows, to fully understand the situation. financial status of the business.

  1. How to read an income statement

The income statement, also known as the profit and loss statement (P&L), summarizes the cumulative impact of income, profit, expense, and loss transactions over a given period of time. This document is often shared as part of quarterly and annual reports and shows financial trends, business activities (income and expenses) and comparisons over specified time periods.

The income statement typically includes the following information:

  • Income:

Amount earned by a business

  • Expense:

Amount spent by a company

  • Cost of Goods Sold (COGS):

The component cost of what is needed to make everything a company sells

  • Gross profit:

Total revenue minus cost of goods sold

  • Organizational results:

Gross profit minus operating expenses

  • Income before tax:

Operating profit minus operating expenses

  • Net revenue:

Profit before tax minus tax

  • Earnings per share (EPS):

Divide net income by total outstanding shares

  • Depreciation :

The extent to which assets (e.g. old equipment) lose value over time


Earnings before interest, taxes, depreciation and amortization

Accountants, investors, and other business professionals regularly review income statements:
  • To understand their business performance:

Is it profitable? How much money is spent to produce a product? Is there money to reinvest in the business?

  • To identify financial trends:

When is the cost highest? When are they the lowest?

  1. How to read the cash flow statement

The purpose of the cash flow statement is to provide a detailed picture of what happened to a company’s cash during a specified period, known as an accounting period. It represents an organization’s short- and long-term performance, based on cash inflows and outflows.

The statement of cash flows is divided into three sections:

Cash flows from operating activities, cash flows from investing activities and cash flows from financing activities.

Operating activities detail the cash flows generated when the Small Business Accounting Services has provided ordinary goods or services and include income and expenses. Investing activities are cash flows from the purchase or sale of assets – often in the form of physical goods, such as real estate or vehicles, and intangible goods, such as patents – using available funds. not debt. Financing activities detail the cash flows from both debt and equity. It is important to note that there is a difference between cash flow and profit. While cash flow refers to the cash flow in and out of a business, profit refers to what is left after all the expenses of the business have been deducted from its income. Both are important numbers to know.

With the cash flow statement, you can see the types of cash-generating activities and use this information to make financial decisions.

Ideally, cash flow from operating profit should regularly exceed net profit, as positive cash flow is a testament to a company’s financial stability and ability to grow its business. However, having positive cash flow doesn’t necessarily mean the business is profitable, which is why you should also analyze your balance sheet and income statement. .

4. How to read the annual report

An annual report is a publication that public companies must issue annually to shareholders to describe their operating and financial conditions.

Annual reports often incorporate editorials and stories in the form of photos, infographics, and letters from the CEO outlining the company’s activities, credentials, and achievements. They give investors, shareholders, and employees more insight into a company’s mission and goals than individual financial statements.

In addition to the editorial, the annual report summarizes financial data and includes a company’s income statement, balance sheet, and cash flow statement. It also provides industry, MD&A, accounting policy and additional information to investors.

In addition to annual reports, the U.S. Securities and Exchange Commission (SEC) requires public companies to file longer, more detailed 10-K reports that report to investors on the state of their finances. Company before they don’t buy or sell stock.

10-K reports are organized according to SEC guidelines and include comprehensive descriptions of the company’s tax practices, corporate arrangements, risks, opportunities, ongoing activities, compensation market operations and management. You can also find detailed discussions of the year’s performance and comprehensive industry and market analysis.

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