Have you ever looked at a company’s profit numbers and thought you knew everything about its financial health?
Many people make this mistake. They see a business earning ₹10 lakhs in yearly profit and assume it’s doing great. But here’s the truth: one financial report alone can be misleading.
To truly understand any business, you need to read three key financial documents together:
- Profit & Loss Statement (P&L)
- Balance Sheet
- Cash Flow Statement
These three reports work as a team. They’re like different chapters of the same book – each telling an important part of the company’s financial story.
Let’s break down how they connect and why it matters for your investment decisions.
What is a Profit & Loss Statement?
The P&L statement is usually the first document people check. It’s simple to understand:
- Shows how much money came in (revenue)
- Shows how much was spent (expenses)
- Shows what’s left over (profit or loss)
Example: A small clothing store makes ₹50 lakhs in sales. After paying for products, rent, staff salaries, and other costs, they have ₹8 lakhs left. That’s their net profit.
But here’s what many people don’t realize: this ₹8 lakhs profit is not cash sitting in the bank.
It’s an accounting number that includes expenses like depreciation (which don’t involve actual cash leaving the business right now).
The P&L also doesn’t tell you what happened to that profit. Did the owners take it home? Did they buy new equipment? We need other reports to find out.
Understanding the Balance Sheet
Think of the Balance Sheet as a photograph of the company’s financial position on a specific date.
It shows three main things:
- Assets – What the company owns (cash, inventory, equipment, buildings)
- Liabilities – What the company owes (loans, unpaid bills)
- Equity – What belongs to the owners
Here’s where it gets interesting: The profit from your P&L statement flows into the Balance Sheet.
That ₹8 lakhs profit gets added to “Retained Earnings” under the Equity section (if no dividends were paid to owners).
Let’s say the clothing store used ₹5 lakhs of that profit to buy new display equipment:
- Assets increase by ₹5 lakhs (new equipment)
- Cash decreases by ₹5 lakhs
- Total assets remain the same, just rearranged
The Balance Sheet changes every time the company buys something, sells something, takes a loan, or pays back debt.
Cash Flow Statement: Where the Real Action Happens
Now comes the most important question: If a company made ₹8 lakhs profit, does it actually have ₹8 lakhs more cash?
The answer is usually no.
This is where the Cash Flow Statement becomes crucial. It tracks actual money movement – not just paper profits.
Real-world example:
- A customer orders ₹3 lakhs worth of clothes but hasn’t paid yet
- Your P&L shows ₹3 lakhs in sales and maybe ₹30,000 in profit
- But your bank account shows zero – no cash received
Similarly, if you buy ₹2 lakhs worth of inventory and pay upfront, that cash leaves your account immediately. But it doesn’t show as an expense in the P&L until you sell those items.
The Cash Flow Statement fixes this confusion by:
- Starting with net profit from the P&L
- Adding back non-cash expenses (like depreciation)
- Adjusting for changes in receivables and payables
- Showing money spent on investments (equipment, expansion)
- Tracking loan payments and new borrowings
How All Three Reports Work Together
Let’s see a complete example:
Starting position: Company has ₹10 lakhs cash in bank
During the year:
- Makes ₹60 lakhs in sales
- Spends ₹52 lakhs on expenses
- Net profit: ₹8 lakhs
- Buys delivery truck for ₹4 lakhs
- Pays ₹2 lakhs dividend to owners
What each report shows:
P&L Statement: ₹8 lakhs profit
Balance Sheet:
- Assets increase by ₹4 lakhs (truck)
- Cash decreases
- Retained earnings increase by ₹6 lakhs (₹8L profit – ₹2L dividend)
Cash Flow Statement:
- Starts with ₹8 lakhs profit
- Minus ₹4 lakhs for truck
- Minus ₹2 lakhs dividend
- Net cash increase: ₹2 lakhs
- Final cash position: ₹12 lakhs
Now you can see the complete picture!
Why This Knowledge is Powerful
Whether you’re investing in stocks, running a business, or studying finance, understanding these connections gives you a huge advantage.
For investors: A company might show consistent profits but struggle with cash flow due to slow-paying customers or heavy loan payments. The P&L won’t reveal this problem – only the cash flow statement will.
For business owners: You might be profitable on paper but still face cash shortages. These reports help you plan better and avoid financial surprises.
For students: This knowledge forms the foundation of financial analysis. Master this, and you’ll understand how successful investors evaluate companies.
Key Questions to Ask
Next time you look at any company’s financials, don’t stop at the profit numbers. Ask these questions:
- Where did the profit actually go?
- How much real cash came into the business?
- What changed in the company’s assets and debts?
- Is the company generating cash or consuming it?
Final Thoughts
Financial statements don’t have to be complicated. Think of them as three different camera angles of the same business:
- P&L: Shows if the business model is working
- Balance Sheet: Shows the financial strength and structure
- Cash Flow: Shows the real money movement
Master these connections, and you’ll see businesses the way professional investors do.
Remember what Warren Buffett says about building your circle of competence. Understanding how money flows through these three reports is a perfect place to start.
Once you grasp this concept, you’ll make smarter investment decisions and better business choices.
The numbers will finally start making sense, and you’ll wonder why it ever seemed complicated in the first place.
