The three financial statements and how they connect

Income statement (profit and loss)

Shows performance over a period.

Revenue                          1,000
– Cost of goods sold (COGS)       (600)
= Gross profit                     400     Gross margin 40%
– Operating expenses (salaries, rent, marketing)  (200)
= EBITDA                           200
– Depreciation & amortisation      (50)
= EBIT (operating profit)          150
– Interest                         (30)
= Profit before tax (PBT)          120
– Tax                              (30)
= Net profit (PAT)                  90     Net margin 9%

Balance sheet

A snapshot of what the company owns and owes at a point in time.

• Assets: non-current (property, plant and equipment, intangibles, long-term investments) and current (cash, receivables, inventory, prepaid expenses).
• Liabilities: non-current (long-term borrowings) and current (payables, short-term loans, accrued expenses).
• Equity: share capital plus reserves and surplus (retained earnings).

Cash flow statement

How cash actually moved, in three sections:

• Operating activities: cash from the core business. Under the indirect method, start with net profit, add back non-cash expenses (depreciation), then adjust for working capital changes (an increase in receivables reduces cash; an increase in payables increases cash).
• Investing activities: buying or selling long-term assets and investments.
• Financing activities: raising or repaying debt, issuing shares, paying dividends.

A company can show a profit and still run out of cash, if customers pay slowly or inventory piles up. "Cash is king" is not a cliché.

How they link (a classic interview question)

If depreciation increases by ₹10 (tax rate 25%):

• Income statement: EBIT falls by 10, tax falls by 2.5, net income falls by 7.5.
• Cash flow statement: net income −7.5, add back depreciation +10 → operating cash flow +2.5 (the tax saving).
• Balance sheet: PP&E −10 (assets); cash +2.5 → total assets −7.5; retained earnings −7.5 (equity). Balanced.

Practise walking through other changes: buying inventory with cash, a customer paying an invoice, issuing debt.

Check yourself

• Why can a profitable company go bankrupt?
• Which statement shows a company's position at a point in time?
• Walk through what happens to all three statements when a company buys a ₹100 machine with cash.