Module 5 — The three financial statements and how to read them

Level: Intermediate · Duration: 5 hours · Tracks: 🟢 🔵 🟣 · Prerequisite: Module 2 (and Module 4 for the 🔵🟣 tracks)

1. Objectives

By the end of this module you will be able to:

1. Prepare an income statement, a balance sheet and a cash flow statement from a trial balance.
2. Explain how the three statements link to each other, and check your work with three linking points.
3. Prepare a cash flow statement by the indirect method and explain the gap between profit and cash.
4. Calculate and read nine core financial ratios for an e-commerce store.
5. Read a store's income statement and judge, in 60 seconds, what its biggest problem is.

2. Core concepts

2.1 Three statements answering three questions

2.2 The shape of an income statement for an e-commerce store

    Gross sales
  − Sales returns and discounts
  ─────────────────────────────
  = Net revenue
  − Cost of goods sold
  ─────────────────────────────
  = Gross profit           ──▶ measures the health of your pricing and your buying
  − Fulfilment costs (payment fees, delivery, platform commissions)
  ─────────────────────────────
  = Contribution margin    ──▶ measures the profitability of a single order
  − Marketing expense
  ─────────────────────────────
  = Profit after marketing ──▶ measures acquisition efficiency
  − Fixed costs (salaries, rent, software, professional fees, depreciation)
  ─────────────────────────────
  = Net profit before tax

Why this shape in particular? The standard order (revenue − cost − administrative expenses) tells a store founder nothing. The order above separates what changes with every order (variable) from what does not (fixed), and that is the only separation that lets you calculate your break-even point and estimate the effect of doubling your sales.

2.3 The three linking points between the statements

        Income statement           Balance sheet             Cash flow
        Net profit  ────────▶  Retained earnings
                                 Cash  ◀────────────────  Closing cash balance
        Depreciation  ──────▶  Accumulated depreciation  ──────▶  added back (non-cash)

The three checking rules — if one of them fails, your work is wrong:

1. Assets = Liabilities + Equity
2. Closing retained earnings = opening + net profit − distributions
3. Closing cash in the cash flow statement = the cash balance on the balance sheet

2.4 Cash flow by the indirect method

You start from net profit and adjust it until you reach cash:

   Net profit
 + Non-cash expenses (depreciation, provisions)
 ± The change in working capital:
      an increase in an operating asset (inventory, receivables, prepayments)  →  subtract
      an increase in an operating liability (payables, accruals, taxes)  →  add
 ─────────────────────────────
 = Cash from operating activities
 ± Investing activities (buying/selling fixed assets)
 ± Financing activities (capital, loans, distributions)
 ─────────────────────────────
 = Net change in cash

The logic in one sentence: an increase in inventory means cash turned into goods ⇒ cash went out ⇒ subtract. An increase in payables means you took goods and did not pay ⇒ the cash stayed with you ⇒ add.

2.5 The nine ratios for an e-commerce store

3. Worked example — the three statements for Nuwa, January 2026

3.1 Income statement for the month ended 31 January 2026

3.2 Balance sheet as at 31 January 2026

A presentation note: VAT is presented on the balance sheet net (output 8,526.00 − input 6,104.40), while it stays as two separate accounts in the books. That is the difference between presentation and recording, and it confuses a lot of people.

3.3 Cash flow statement (indirect) for January 2026

The triple check:
1. Assets 259,233.60 = liabilities 84,921.60 + equity 174,312.00 ✓
2. Retained earnings 0 + 24,312.00 − 0 = 24,312.00 ✓
3. Closing cash 184,853.60 = the bank balance on the balance sheet ✓

3.4 The reading — what do these statements actually say?

The red flag explained: every dirham of profit produced only 36 fils of cash. The cause is not sickness, it is growth: inventory and prepaid rent swallowed 50,880 dirhams. But the number carries a real warning — if the store keeps growing at this pace and its supplier stops granting 30 days of credit, it will need extra cash before it feels any problem at all in the income statement.

The decision that follows: fix the supplier's credit terms in writing before you scale your orders, and start now on a 13-week cash forecast (Module 10).

4. Exercises

E5.1 — The income statement (beginner). From the following trial balance, prepare an income statement in the stepped shape:
sales 240,000 · returns 14,400 · cost of goods sold 96,000 · gateway fees 5,600 · delivery 7,200 · platform commissions 9,800 · marketing 46,000 · salaries 28,000 · rent 6,000 · software 2,400 · depreciation 1,100.
Calculate: net revenue, gross profit, contribution margin, profit after marketing, net profit, and four percentages.

E5.2 — The balance sheet (beginner→intermediate). Arrange the following into a properly classified balance sheet:
bank 88,400 · inventory 132,000 · receivable from the payment gateway 21,300 · equipment 40,000 · accumulated depreciation 6,500 · accounts payable 74,000 · tax payable 9,100 · long-term bank loan 60,000 · capital 100,000 · retained earnings ?
Calculate retained earnings, then the current ratio, and comment on it in two lines.

E5.3 — Cash flow (intermediate). Net profit 45,000 · depreciation 3,000 · inventory rose from 60,000 to 96,000 · accounts payable rose from 40,000 to 52,000 · the receivable from the gateway rose by 8,000 · asset purchases 15,000 · distributions to the owner 20,000. Prepare the statement, calculate the net change in cash and the cash conversion ratio, then explain the result in two lines.

E5.4 — Fast diagnosis (intermediate). Three stores, each with revenue of 500,000:

For each store: calculate net profit, name the single biggest problem, and propose one specific action that can be carried out within 30 days.

E5.5 — Linking the statements (advanced). A store: opening retained earnings 82,000, closing 96,500, and 12,000 distributed to the owner. What was the net profit for the period? Then: opening cash 40,000 and closing cash 31,000, operating cash was +18,000 and financing was −12,000. What was the investing cash flow? And what most likely happened?

5. Mini project — "The monthly financial pack"

Deliverable: three statements linked automatically + a one-page summary.

What is required:

1. Build the three statements in a single file, all of them reading from the trial balance through formulas — with no manual entry.
2. Add the three check cells (balance sheet balances, retained earnings, cash agreement) showing ✓ or the difference.
3. Add a dashboard of the nine ratios with a colour indicator for each ratio against its benchmark.
4. Write a summary page for an investor or a partner: the three most important numbers, the biggest risk, and the proposed action — with no accounting jargon.
5. A sensitivity test: change January sales from 99,500 to 150,000 while keeping costs at a constant percentage, and record what happened to net profit and to operating cash. Explain why the two did not move by the same percentage.

Acceptance criteria:
- [ ] The three statements match the worked example's figures exactly.
- [ ] All three check cells show ✓.
- [ ] No numeric cell in the statements is typed by hand — all of them are formulas from the trial balance.
- [ ] The summary page contains no unexplained accounting jargon.
- [ ] The explanation of the sensitivity test mentions working capital explicitly.

6. The test

10 questions · pass 7/10.

7. Completion standard

Mastery level (optional): prepare the three-statement pack for your real store for the last completed month, and show it to someone who does not understand accounting. If, after reading it, they cannot tell you whether the month was good or bad and why, the problem is in your presentation, not in their understanding.