FOUNDATION 04 / Business & data
Read financial statements
Connect assets, earnings and cash without confusing profit with money in the bank.
By the end of this lesson
- Link the three main statements.
- Explain accrual profit versus operating cash flow.
- Identify questions that need notes and supporting evidence.
IBBC Capital Finance Foundations · Original content drafted with AI assistance. IBBC Capital is responsible for editorial review and content. General education, not an official CFA Institute curriculum or credential.
A snapshot and two stories over time
The balance sheet is a snapshot: assets = liabilities + equity. Assets are resources; liabilities are obligations; equity is the residual accounting interest. Book equity is not automatically market value.
The income statement reports performance over a period. The cash-flow statement explains movements in cash over a period. Always check dates, currency, units, consolidation scope and whether figures are audited.
Revenue recognition is not cash collection
Accrual accounting records revenue and expenses when recognition criteria are met, not simply when cash moves. A credit sale can increase revenue and receivables while leaving cash unchanged initially.
Depreciation allocates an asset’s cost over its useful life; it is not a cash payment in the period of depreciation. That does not mean assets are free: acquisition and replacement can require substantial cash.
A simple operating-cash bridge
In a simplified indirect reconciliation, CFO ≈ net income + noncash depreciation − increase in receivables − increase in inventory + increase in payables. Decreases reverse the signs. This lesson excludes other adjustments.
An increase in receivables uses cash relative to recognized profit; an increase in payables delays cash payments. Classification of interest and dividends can depend on the reporting framework and policy, so read the notes rather than assuming universal presentation.
Read the notes and reconcile
Look for revenue policies, estimates, related-party transactions, debt maturities, contingencies and subsequent events. Compare cash balances between statements and investigate unexplained differences. An audit opinion is evidence about reporting, not a guarantee of investment quality.
For an exercise, annotate each number with its source statement and date. Write “unknown” when information is absent. Avoid filling a missing figure with an optimistic assumption disguised as a fact.
Reconcile profit of 120 to cash
- Net income 120; depreciation 20; receivables rise 15.
- Inventory rises 10; payables rise 5.
- Simplified CFO = 120+20−15−10+5 = 120.
- This is an exercise with selected adjustments, not a complete reporting template.
Try before looking at the explanation
Change one input in the practice tool below. Predict the direction first, calculate second, then explain why it changed.
Work the numbers
Common mistakes to catch
- Treating every sale as cash received.
- Adding an inventory increase when reconciling profit to cash.
- Ignoring units such as thousands versus millions.
Knowledge check · 6 original questions
Answer all six. At least five correct marks the lesson complete for self-study. You can retry; this is not a credential.
Keep these ideas
- Separate stock measures at a date from flow measures over a period.
- Use the notes to understand estimates and classifications.