A company’s financial reports can look like three unrelated documents: the profit and loss account, the balance sheet and the cash flow statement. They are really three views of the same activity, and once you see the connections, each one becomes easier to read.
One business, three questions
- Profit and loss: did the business earn more than it spent during the period?
- Balance sheet: what does the business own and owe on a particular date?
- Cash flow: where did cash actually come from and go during the period?
A tiny example
Take a fictional bakery, Annapurna Bakes, in its first year. The owner puts in ₹10 lakh of her own money and borrows ₹5 lakh. She buys ovens for ₹8 lakh. During the year she sells ₹20 lakh of bread, of which ₹2 lakh has not yet been collected from customers. Ingredients, wages and rent cost ₹14 lakh, all paid in cash. Depreciation on the ovens is ₹1 lakh. Interest on the loan is ₹0.5 lakh.
Profit and loss. Sales ₹20 lakh, less costs ₹14 lakh, less depreciation ₹1 lakh, less interest ₹0.5 lakh gives a profit of ₹4.5 lakh (before tax, to keep it simple).
Cash flow. Cash received from customers is ₹18 lakh, because ₹2 lakh is still outstanding. Cash paid for costs is ₹14 lakh and interest ₹0.5 lakh. Operating cash flow is therefore ₹3.5 lakh, lower than profit. Cash spent on ovens was ₹8 lakh (investing). Cash raised was ₹15 lakh (financing). Opening cash was zero, so closing cash is 3.5 − 8 + 15 = ₹10.5 lakh.
Balance sheet. Assets: cash ₹10.5 lakh, receivables ₹2 lakh, ovens net of depreciation ₹7 lakh, total ₹19.5 lakh. Liabilities and equity: loan ₹5 lakh, the owner’s capital ₹10 lakh plus retained profit ₹4.5 lakh, total ₹19.5 lakh. It balances, because it must.
The links to look for
- Profit from the P&L flows into equity on the balance sheet.
- The difference between profit and operating cash flow is explained by changes on the balance sheet, here the unpaid ₹2 lakh and the depreciation.
- Closing cash on the cash flow statement equals the cash line on the balance sheet.
Why it matters
A business can be profitable and short of cash if customers pay slowly. It can show a loss and still generate cash if depreciation is heavy. Reading one statement alone hides this, and reading all three together shows the difference immediately.
The bakery in year two
To see why the statements need each other, extend the example. In year two, Annapurna Bakes sells ₹24 lakh of bread, but customers are slower to pay, so receivables rise from ₹2 lakh to ₹6 lakh. Cash costs are ₹16 lakh, depreciation is ₹1 lakh and interest is ₹0.4 lakh.
- Profit and loss. 24 − 16 − 1 − 0.4 = ₹6.6 lakh profit, up from ₹4.5 lakh.
- Cash flow. Cash collected is 24 − 4 (the rise in receivables) = ₹20 lakh. Less cash costs of 16 and interest of 0.4 gives operating cash flow of ₹3.6 lakh.
Profit rose by almost half, but operating cash flow barely moved. A reader looking at the P&L alone would see a good year. A reader who also checks the cash flow and the balance sheet sees that most of the extra profit is sitting in unpaid invoices. That is not a disaster, since customers may pay next month, but it is a different story, and it is the kind of difference that can only be spotted when the statements are read together. Tax has been left out of both years to keep the arithmetic clear.
Where each statement misleads when read alone
- Profit and loss alone hides cash. Profit can be tied up in receivables or inventory.
- Balance sheet alone is a snapshot. It cannot tell you whether the position is improving or worsening.
- Cash flow alone can be flattered by borrowing or by selling assets, which bring in cash without being part of everyday earnings.
A reading routine
- Start with the P&L: revenue, operating profit, net profit.
- Move to the cash flow: is operating cash flow in the same range as profit? If not, why?
- Check the balance sheet: debt, cash, receivables and inventory, and how they have changed since the previous period.
- Read the notes. Accounting policies and contingent liabilities are explained there.
A word on terminology
Indian company accounts use the terms “statement of profit and loss”, “balance sheet” and “statement of cash flows”. Quarterly results often include only a condensed profit and loss, with the balance sheet and cash flow published half-yearly and annually. So it is normal that a quarterly filing does not contain all three. The half-year and year-end filings are the ones to use when you want the full picture.
Real companies have many more lines, but the logic is identical. When you meet a new company’s statements, look for the three links above first. For a plain-language walk-through of each statement and how they connect, see how the profit and loss, balance sheet and cash flow fit together. Once the statements make sense, the next step is usually financial ratios in plain language, which turn them into comparable numbers.
The skill is not memorising line items; it is knowing that every number in one statement leaves a footprint in another.
