The Three Financial Statements

The P&L

The P&L looks at sales: what you sold in a period, what it cost to make those sales, your expenses, and, if anything is left over, your profit. Just as Sales got the fancier name P&L, its lines get fancier names too.

Notice that Profit is now Net Income. We've all said profit our whole lives, so why Net Income? Accounting and finance have lots of names for the same thing, to confuse people who aren't in the business, so we can keep our jobs! It gets crazier: even the word finance is pronounced differently by the people who work in it. Not "FYE-nance" but "fin-ANCE."

Accounting and finance aren't hard at all. They're just intentionally intimidating, to keep people out.

Cash Flow

Cash Flow hasn't changed its name much, because it's very straightforward: cash. There are three essential things to know about it:

1. Cash is not profit. This is critical! Even in our Lemonade Stand, we had $20 of profit but $35 of cash. Profit (oops, Net Income) is one part of cash, but not the only part, and often the least important one.
2. CASH IS NOT PROFIT. I don't remember if we covered this already, but it bears repeating. We've already seen one reason: debt. Another is investment.
3. CASH IS NOT PROFIT. When we see the full Cash Flow Statement, you'll see its whole reason for existing is to translate between profit and cash.

The Balance Sheet

We've seen that What the Company Owns equals What the Company Owes. In the early days of accounting, what the company Owned went on the left and what it Owed went on the right. Since the two sides always balance, it got the name Balance Sheet.

Time to change some more names:

• What the Company Owns is called Assets. Assets can be tangible (computers, equipment, land) or intangible (patents, licenses).
• What the Company Owes to Others is called Liabilities. These are specific amounts owed by a specific date to someone else.
• What the Company Owes to Owners is called Owners' Equity. No law says when or how much the company pays the owners, since the owners decide. It's basically the company's net worth "on the books."

So our simple equation becomes the Accounting Equation, the central idea in accounting and a handy summary of the Balance Sheet:

Assets = Liabilities + Owners' Equity

In my class at Pepperdine I drum it in every single class. I have my students shout it out like maniacs when guest speakers come.

The Three Statements Side by Side

Here are all three for a small sample company's month. You'll take them apart line by line in the next three lessons.

What the Three Statements Tell Us

The P&L shows sales: how much you made, what it cost, and what's left. Revenue is the "Top Line" and Net Income is the "Bottom Line." But the P&L doesn't show your cash. Cash Flow shows where cash came from, where it went, and how much you have, but not what you own or owe. The Balance Sheet shows what you have and how much you owe, and to whom.

Put them together and you have a 360 degree view of a business: sales, cash, and own and owe. Every business, school and nonprofit uses them, or should.