Chapter 14: Financial Statements -- Reading the Scoreboard

Tax year notice: This guide uses 2025/26 tax year figures (6 April 2025 -- 5 April 2026). Check gov.uk for the latest rates.

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Why profitable businesses go bust

Here's a fact that surprises most people: a business can be profitable and still run out of money. Profit and cash are not the same thing.

If Sam sells 10,000 worth of clothes in December but customers don't pay until February, the Profit and Loss statement shows a great December. But Sam's bank account doesn't have the money to pay for more stock in January. That's a cash flow problem, and it kills more businesses than lack of profit.

Financial statements exist to show you three different angles on the same business. Together, they give you the full picture.

The three statements

1. Profit and Loss (P&L) -- "Are we making money?"

The P&L (also called the income statement) shows your revenue minus expenses over a period -- usually a month, quarter, or year. The bottom line is your profit or loss.

Structure:

Line	What it is
Revenue	Total income from sales
- Cost of goods sold	Direct costs of what you sold (stock, materials)
= Gross profit	Revenue minus direct costs
- Operating expenses	Rent, salaries, marketing, utilities, insurance
= Operating profit	Profit from core business activities
- Interest and tax	Loan interest, Corporation Tax
= Net profit	The final profit after everything

The P&L tells you whether your pricing works, whether your costs are under control, and whether the business is fundamentally viable. But it doesn't tell you whether you actually have money in the bank.

Jargon Buster: Gross profit vs net profit Gross profit is revenue minus the direct cost of what you sold. It tells you if your pricing covers your product costs. Net profit is what's left after ALL expenses. It tells you if the business is actually making money overall.

2. Balance Sheet -- "What do we own and owe?"

The Balance Sheet is a snapshot of your business at a single point in time. It shows three things:

Assets -- what the business owns:

• Cash in the bank
• Money owed by customers (trade debtors / accounts receivable)
• Stock/inventory
• Equipment, vehicles, property
• Prepaid expenses (e.g., insurance paid for the year ahead)

Liabilities -- what the business owes:

• Money owed to suppliers (trade creditors / accounts payable)
• Tax owed to HMRC
• Loans
• VAT collected but not yet paid to HMRC

Equity -- the owner's stake:

• Share capital (what was invested)
• Retained profits (profits kept in the business over time)

The fundamental equation: Assets = Liabilities + Equity. Always. If it doesn't balance, something is wrong.

The Balance Sheet answers: "If we stopped trading today, what would be left after paying everyone we owe?"

3. Cash Flow Statement -- "Where did the money go?"

The Cash Flow Statement tracks actual money moving in and out of the bank. It's split into three sections:

Operating activities -- cash from day-to-day trading:

• Cash received from customers
• Cash paid to suppliers
• Cash paid in wages, rent, utilities

Investing activities -- cash spent on long-term items:

• Buying equipment or vehicles
• Selling assets

Financing activities -- cash from loans and investments:

• Taking out a loan
• Repaying a loan
• Dividends paid to shareholders

The Cash Flow Statement explains why your bank balance changed. If the P&L says you made 25,000 profit but your bank only grew by 8,000, the Cash Flow Statement tells you where the other 17,000 went (stock, equipment purchases, loan repayments, tax payments).

How they connect

The three statements are linked:

• Net profit from the P&L feeds into retained earnings on the Balance Sheet
• Cash from operations on the Cash Flow Statement adjusts the P&L profit for non-cash items and timing differences
• Cash and bank balances on the Balance Sheet must match the closing balance on the Cash Flow Statement

Think of it this way: the P&L tells you the score, the Balance Sheet tells you the league table, and the Cash Flow Statement tells you how the game was actually played.

Filing requirements

Limited companies must file accounts with both Companies House and HMRC:

Where	What	Deadline
Companies House	Annual accounts (Balance Sheet + notes, P&L optional for micro/small companies)	9 months after year end
HMRC	Full accounts with Corporation Tax return (CT600)	12 months after year end

Micro-entity (turnover under 632,000, Balance Sheet under 316,000, under 10 employees): Can file abbreviated accounts with Companies House -- just the Balance Sheet and limited notes. No P&L required publicly.

Small company (turnover under 10.2 million): Can file abridged accounts.

Sole traders don't file formal accounts. Your Self Assessment includes a summary of income and expenses, but you don't need to prepare a formal P&L or Balance Sheet for HMRC. You should still create them for your own understanding.

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Real Scenario: Sam's first year as a limited company

Sam's Vintage Ltd has completed its first financial year. Here are the three statements:

Sam's P&L (Year 1)

Line	Amount
Revenue (Unbought sales)	120,000
Cost of goods sold (stock)	-42,000
Gross profit	78,000
Wages (Sam + Alex)	-27,570
Employer NI	-3,223
Pension contributions	-795
Unbought fees	-8,400
Shipping	-6,200
Rent (storage unit)	-3,600
Insurance	-950
Accountant	-1,200
Software and tools	-480
Marketing	-1,800
Other expenses	-720
Operating profit	23,062
Corporation Tax (19%)	-4,382
Net profit	18,680

Sam's Balance Sheet (Year End)

Assets		Liabilities
Bank balance	12,400	Trade creditors (suppliers owed)	3,200
Trade debtors (money owed to Sam)	4,800	VAT owed to HMRC	4,100
Stock (unsold inventory)	8,500	Corporation Tax owed	4,382
Equipment	2,200	Total liabilities	11,682
Total assets	27,900
		Equity
		Share capital	1
		Retained profit	16,217
		Total equity	16,218
		Liabilities + Equity	27,900

The cash flow puzzle

Sam made 18,680 net profit. But the bank only has 12,400 (and Sam started with 2,000). So cash grew by 10,400 -- not 18,680.

Where did the difference go?

• 8,500 is tied up in unsold stock (bought but not yet sold)
• 4,800 is owed by customers who haven't paid yet (trade debtors)
• Offset by 11,682 that Sam owes to others (liabilities)

The lesson: Profit is an accounting concept. Cash is what pays the bills. Sam's business is profitable but a significant portion of that profit is locked in stock and unpaid invoices.

Real Scenario: Steve reads his numbers

Steve hasn't incorporated, but he still generates a P&L from his accounting software to understand his business:

Line	Amount
Revenue	78,000
Materials	-8,400
Gross profit	69,600
Jordan's salary + costs	-28,363
Vehicle costs	-5,400
Tools and equipment	-1,800
Insurance	-960
Waste disposal	-1,440
Phone	-360
Accountant	-500
Net profit	30,777

Steve's gross margin is 89% (mostly labour, few material costs -- typical for services). But after Jordan's salary, the biggest expense, net profit drops to 39%.

Steve's key insight: each additional gardener costs roughly 28,000 in total but can generate 40,000--50,000 in additional revenue. The maths works, but only if Steve can fill their schedule.

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Cost Table: Filing deadlines and penalties

Filing	Deadline	Late penalty
Companies House annual accounts	9 months after year end	150 (up to 1 month), 375 (1--3 months), 750 (3--6 months), 1,500 (6+ months)
HMRC Corporation Tax return	12 months after year end	100 (1 day), 200 (3 months), 10% of tax (6 months), 20% of tax (12 months)
Corporation Tax payment	9 months and 1 day after year end	Interest accrues from due date

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Jargon Buster

Term	Plain English
Profit and Loss (P&L)	A statement showing revenue minus expenses over a period. Also called the income statement
Balance Sheet	A snapshot of what the business owns (assets), owes (liabilities), and the owner's stake (equity) at a point in time
Cash Flow Statement	A record of actual cash moving in and out of the business, explaining why the bank balance changed
Revenue	Total income from sales before any deductions
Gross profit	Revenue minus the direct cost of goods sold
Net profit	Profit after all expenses, including tax
Assets	What the business owns -- cash, stock, equipment, money owed by customers
Liabilities	What the business owes -- supplier bills, tax, loans
Equity	The owner's stake -- share capital plus retained profits
Trade debtors (accounts receivable)	Money owed to you by customers who haven't paid yet
Trade creditors (accounts payable)	Money you owe to suppliers you haven't paid yet
Retained profits	Net profit kept in the business rather than paid out as dividends
Micro-entity	A very small company (turnover under 632,000) that can file simplified accounts
Gross margin	Gross profit as a percentage of revenue -- shows how much you keep after direct costs