The three statements and how they link

Almost every finance interview touches on accounting, because the financial statements are how you see inside a business. You do not need to be an accountant. You do need to know what each statement shows, the main lines on it, and how the three connect. UK listed companies report under IFRS, so this lesson uses IFRS names, with the terms you will also hear in interviews alongside.

The income statement

The income statement shows performance over a period, usually a year or half-year. It starts with revenue and subtracts costs until it reaches profit. Revenue is recognised when goods or services are delivered, not when cash arrives, and costs are matched to the period they relate to.

Operating profit is often called EBIT, earnings before interest and tax. EBITDA adds back depreciation and amortisation, which are non-cash charges, so it is a rough measure of operating cash generation. EBITDA is not an IFRS line, so companies define it themselves in their results. The UK main rate of corporation tax is 25%, which is why many UK examples use that rate.

The balance sheet

The balance sheet, called the statement of financial position under IFRS, is a snapshot at one date. It lists what the company owns and what it owes, and it always balances:

• Assets include cash, trade receivables (money customers owe), inventories, and property, plant and equipment (PP&E)
• Liabilities include trade payables (money owed to suppliers), borrowings, and lease liabilities
• Equity is share capital plus retained earnings, the profits kept in the business over the years

Since IFRS 16, most leases appear on the balance sheet: the company records a right-of-use asset and a lease liability. This matters later for valuation, because lease costs move from operating expenses into depreciation and interest, which raises EBITDA.

The cash flow statement

Profit is not cash. A company can report a profit and still run out of money if customers pay slowly or it spends heavily on equipment. The cash flow statement shows where cash actually came from and went during the period, in three sections.

• Operating activities: cash from running the business
• Investing activities: buying and selling long-term assets, such as capital expenditure on equipment
• Financing activities: borrowing and repaying debt, issuing shares, and paying dividends

Most companies use the indirect method for operating cash flow. It starts with profit, adds back non-cash charges such as depreciation, and adjusts for changes in working capital. If receivables or inventories rise, cash is tied up, so the increase is subtracted. If payables rise, the company is paying suppliers later, so the increase is added.

Under IFRS, companies have some choice about where interest and dividends appear. Interest paid can be shown in operating or financing activities, so check the notes before comparing two companies. A newer standard, IFRS 18, is set to narrow these choices for most companies.

How the statements link

Interviewers love the links, because they show whether you understand the statements as one system rather than three lists. These are the ones to know.

• Profit for the year is the starting point of the cash flow statement
• Profit for the year, less dividends, is added to retained earnings on the balance sheet
• Depreciation reduces profit, is added back in operating cash flow, and reduces PP&E
• Capital expenditure is an investing outflow and increases PP&E
• Changes in receivables, inventories and payables on the balance sheet drive the working capital lines in operating cash flow
• New borrowing or repayments appear in financing cash flow and change borrowings on the balance sheet
• Closing cash on the cash flow statement equals cash on the closing balance sheet

Why each statement matters

A common question is: "If you could only see one statement, which would you choose?" A good answer is the cash flow statement, because cash is harder to flatter with accounting choices and shows whether the business can fund itself. A strong candidate adds a caveat: you would still want the balance sheet to see debt and the income statement to understand margins. There is no single right answer, so give a reason.