Bookkeeping Basics / Lesson 10

Lesson 10 of 12

In this lesson you will:

Build a profit and loss statement from a month of transactions.
Build the balance sheet and check that it balances.
Explain why profit and cash are different, using a cash flow statement.
Use a few simple measures to read the statements.

The month's transactions

Rivera Cleaning starts in March. Everything that happened:

The owner puts $5,000 into the business bank account.
Buys cleaning equipment for $2,400, paid from the bank.
Invoices customers $6,000 for cleaning; $4,500 is paid by month end.
Receives a $800 bill for supplies (all used in March) and pays $500 of it.
Pays wages of $2,000 (payroll taxes left out to keep it short).
Pays rent of $1,000.
Records $40 of depreciation on the equipment.
The owner takes a $600 draw.

1. The profit and loss statement

Also called the income statement. It covers a period (here, March) and shows income minus expenses.

Rivera Cleaning, profit and loss, March
	Amount
Cleaning income	$6,000
Wages	−$2,000
Rent	−$1,000
Supplies	−$800
Depreciation	−$40
Net income	$2,160

The $600 draw is not on the profit and loss. It is not an expense of the business; it is the owner taking out some of the equity. The full $6,000 of income counts on accrual, even though $1,500 has not been collected, and the full $800 of supplies counts even though $300 is unpaid.

2. The balance sheet

It shows the position at a date (here, March 31): the accounting equation from lesson 2, written out.

Rivera Cleaning, balance sheet, March 31
	Amount
Bank	$3,000
Accounts receivable	$1,500
Equipment $2,400, less accumulated depreciation $40	$2,360
Total assets	$6,860
Accounts payable	$300
Total liabilities	$300
Owner contributions	$5,000
Owner draws	−$600
Net income for March	$2,160
Total equity	$6,560
Total liabilities and equity	$6,860

Where did the $3,000 in the bank come from? $5,000 + $4,500 collected − $2,400 equipment − $500 supplies paid − $2,000 wages − $1,000 rent − $600 draw = $3,000. Total assets of $6,860 equal liabilities of $300 plus equity of $6,560. The statement balances.

3. The cash flow statement

Rivera made $2,160 of profit, and the bank went from $0 to $3,000. But $5,000 of the cash came from the owner, not from customers. The statement of cash flows sorts every movement of cash into three sections, so you can see where it really came from.

Rivera Cleaning, statement of cash flows, March (indirect method)
	Amount
Net income	$2,160
Add back depreciation (an expense that used no cash)	+$40
Less increase in accounts receivable (earned, not collected)	−$1,500
Add increase in accounts payable (expensed, not paid)	+$300
Cash from operating activities	$1,000
Equipment purchased	−$2,400
Cash from investing activities	−$2,400
Owner contributions	+$5,000
Owner draws	−$600
Cash from financing activities	$4,400
Net change in cash (from $0 to $3,000)	$3,000

The business's operations brought in only $1,000 of cash in March, though it earned $2,160 of profit. The gap is mostly the $1,500 customers still owe. That is the most common reason a profitable small business runs short of cash.

How the three connect

Net income from the profit and loss flows into equity on the balance sheet.
The change in the bank balance on the balance sheet is exactly what the cash flow statement explains.
At year end, the year's net income moves into retained earnings and the profit and loss starts again at zero.

Reading them: a few simple measures

Measure	Formula	Rivera in March
Net profit margin	Net income ÷ income	$2,160 ÷ $6,000 = 36%
Working capital	Current assets − current liabilities	($3,000 + $1,500) − $300 = $4,200
Current ratio	Current assets ÷ current liabilities	$4,500 ÷ $300 = 15 to 1
Days to collect (rough)	Receivables ÷ income × days in period	$1,500 ÷ $6,000 × 31 = about 8 days

One month on its own says little. Compare each month with the one before, with the same month last year and with your budget.

Key terms

Try it

Profit and loss template: Fill in Rivera's numbers or your own.
Balance sheet template: Check that your own assets equal liabilities plus equity.
Cash flow forecast template: Look ahead, not just back.
Break-even calculator: How much you need to sell to cover fixed costs.

Practise in AcboBooks: open Profit & Loss, Balance Sheet and Statement of Cash Flows for the same month in the sample company and trace how they connect. Free 15-day trial.

Check your understanding

5 questions · pass with 4 right

Pick an answer to see if it is right and why. Nothing is sent anywhere; your result is kept in this browser.

1. Which statement shows the business's position at a single date?

2. Why is the owner's $600 draw not on Rivera's profit and loss?

3. Rivera earned $2,160 but operating cash flow was only $1,000. What was the main reason?

4. In the cash flow statement, why is depreciation added back to net income?

5. Rivera has $4,500 of current assets and $300 of current liabilities. What is its working capital?

0 of 5 answered.

Part of Bookkeeping Basics, a free course from AcboBooks LLC. General information, not tax, legal or accounting advice. Last reviewed October 25, 2026.

Financial statements: P&L, balance sheet and cash flow