---
name: financial-statements-literacy
description: Read a profit and loss, balance sheet, and cash flow statement well enough to see what a business is actually doing. Use when reviewing your own numbers, a partner's, or an acquisition target's.
---

# Financial statements literacy

Three statements describe a business from three angles, and the story
only makes sense when read together. Profit without cash, or growth
funded by debt, are visible immediately to someone who reads all three
and invisible to someone who reads one.

## Method

1. **Read the cash flow statement first.** Profit is an accounting
   judgement; cash movement is closer to fact, and businesses fail from
   running out of cash rather than from reporting a loss.
2. **Trace how profit differs from cash.** Working capital changes,
   capitalised costs, and depreciation explain the gap, and a large
   unexplained gap is the question to ask.
3. **Read the balance sheet for obligations.** What is owed and when,
   because a solvent-looking business with debt maturing next quarter is
   a different business.
4. **Distinguish recurring from one-off.** A profitable year containing
   an asset sale is not a profitable business, and this is the most
   common presentational distortion.
5. **Compare periods, not just levels.** Direction and rate of change
   carry more information than any single figure.
6. **Check revenue recognition timing.** When revenue is booked relative
   to cash and delivery changes the picture substantially (see
   revenue-recognition-basics).
7. **Read the notes.** Accounting policies, contingencies, and related
   party transactions live there, and that is where the material
   surprises are.

## Boundaries

This is reading, not accounting: preparing statements and forming an
audit opinion require qualified professionals, and none of this is
financial advice. Statements can be technically correct and misleading.
Small company accounts are often abbreviated and omit what you most want
to know.