Linked Financial Statements
Each statement answers one question:
| Statement | Question |
|---|---|
| Profit or loss and other comprehensive income | What performance was recognised during the period? |
| Changes in equity | Why did each equity component change? |
| Financial position | What resources, obligations and equity exist at the date? |
| Cash flows | Why did cash and cash equivalents change? |
| Notes | Which policies, estimates, disaggregations and risks explain the totals? |
The notes are part of the financial statements, not optional commentary.
Read the date before the amount
Profit, equity movements and cash flows describe a period; financial position describes a date. A year's revenue cannot be compared directly with closing cash as if they were alternative measures of the same thing. Opening balances plus period movements produce closing balances.
Begin by completing the adjustments and classifying the balances in the adjusted trial balance. Revenue and expenses determine profit, which then updates equity. Closing assets, liabilities and equity appear in the statement of financial position. To prepare cash flows, you also need opening balances and transaction details: a closing trial balance alone cannot reveal all receipts, payments or non-cash transactions.
Use the adjustments-to-statements case to practise that preparation sequence. It is a separate sole-trader example; Northstar below is a company, so it distributes dividends rather than drawings.
Northstar’s 2026 statement set
The statements are deliberately condensed, with amounts shown in £000.
Statement of profit or loss
| 2026 | |
|---|---|
| Revenue | 600 |
| Cost of sales | (360) |
| Gross profit | 240 |
| Operating expenses, including depreciation of 30 | (150) |
| Operating profit | 90 |
| Finance costs | (10) |
| Profit before tax | 80 |
| Income tax expense | (20) |
| Profit for the year | 60 |
Statement of changes in equity
| £000 | |
|---|---|
| Opening equity | 150 |
| Profit for the year | 60 |
| Dividends | (10) |
| Closing equity | 200 |
Dividends are distributions to owners, not operating expenses.
Statement of financial position
| Assets | £000 | Liabilities and equity | £000 |
|---|---|---|---|
| Cash | 60 | Trade payables | 80 |
| Trade receivables, net | 90 | Other current liabilities | 45 |
| Inventory | 100 | Borrowings | 160 |
| PPE, net | 230 | Other non-current liabilities | 45 |
| Other non-current assets | 50 | Total liabilities | 330 |
| Equity | 200 | ||
| Total assets | 530 | Total liabilities and equity | 530 |
Condensed statement of cash flows
| £000 | |
|---|---|
| Opening cash and cash equivalents | 45 |
| Net cash from operating activities | 65 |
| Purchase of PPE | (80) |
| New borrowings | 40 |
| Dividends paid | (10) |
| Closing cash and cash equivalents | 60 |
Four links to verify
- Profit of 60 enters changes in equity.
- Closing equity of 200 enters financial position.
- Cash-flow closing cash of 60 equals the balance-sheet cash figure.
- PPE roll-forward is 180 opening + 80 additions − 30 depreciation = 230 closing.
These checks can reveal omissions. Even when the figures reconcile, you still need to check classification, measurement and disclosure.
Why profit differs from operating cash
Starting from profit, operating cash adjusts for:
- non-cash expenses such as depreciation;
- gains or losses classified elsewhere in cash flows;
- receivable, inventory, payable and accrual movements;
- cash taxes and interest under the applicable classification policy.
Northstar can report £60,000 profit and £65,000 operating cash because accruals and non-cash items offset differently. A ratio near one is not a universal quality threshold.
Derive the working-capital signs
Assume no write-offs or other receivable movements. Opening receivables plus credit sales minus customer receipts equals closing receivables. If receivables rise, some recognised sales have not yet produced cash: subtract that increase when reconciling the relevant accrual profit to cash.
| Movement, other things equal | Cash implication relative to accrual profit |
|---|---|
| Receivables increase | Less cash collected than credit revenue recognised |
| Inventory increases | Purchases exceed inventory expensed as cost of sales; subtract the increase |
| Trade payables increase | Some purchases remain unpaid; add the increase |
| Depreciation expense | Reduces profit without a current cash payment; add it back |
These adjustments explain the difference between profit and cash; they are not additional receipts or payments. Adding back depreciation does not recover the equipment's purchase price, which is reported separately when paid. The condensed Northstar data lacks some of the tax, interest and working-capital details needed to reconstruct the £65,000 operating cash subtotal. A full reconciliation therefore requires more information, not invented balancing figures.
Presentation is changing
IFRS 18 applies for annual periods beginning on or after 1 January 2027 and replaces IAS 1. Among other changes, it:
- introduces defined income-statement categories and subtotals, including operating profit and profit before financing and income taxes;
- requires disclosures for specified management-defined performance measures;
- strengthens aggregation and disaggregation requirements.
It mainly changes presentation and disclosure, not the recognition of Northstar’s bike sale or lease liability. Unilever’s 2025 Annual Report describes its assessment and expected presentation/MPM effects.
For US public business entities, FASB’s ASU 2024-03 expense-disaggregation project has future effective dates beginning after 15 December 2026. Do not treat a future-effective disclosure rule as already mandatory for an earlier period.
Quick check
Northstar forgets £5,000 accrued wages. State the direction of error in profit, liabilities and equity.