Definition

Financial statements are the structured reports in which a business communicates its financial performance and position to shareholders, lenders and regulators. Under the Companies Act 2006, UK companies must prepare annual accounts comprising at least a profit and loss account and a balance sheet; larger entities must also include a cash flow statement and notes. The applicable standards are FRS 102 for most UK private companies, and IFRS as adopted in the UK for listed entities. The statements must give a “true and fair view” of financial position and performance.

Why this matters for Accounting Principles & Procedures

  • Level 1 knowledge: you must name the three primary financial statements and describe what each one discloses.
  • Surveyors regularly work with clients whose financial statements reveal their ability to fund property transactions, service leases or maintain their portfolio.
  • Investment property companies and corporate occupiers file statutory accounts containing information directly relevant to valuation, lease advisory and transactional work.
  • Understanding financial statements allows candidates to identify financially stressed clients early, which is relevant to both client care and professional ethics.
  • The three statements are interconnected: profit flows to equity on the balance sheet, and both are reconciled to cash movements in the cash flow statement.

Key principles

The profit and loss account (income statement)

The profit and loss account (P&L) shows trading performance over a period, typically 12 months. Starting with revenue, it deducts cost of sales to produce gross profit, then deducts overheads to arrive at operating profit. Interest and tax are then deducted to produce net profit. For a surveying practice, the P&L reveals whether fee income is sufficient to cover costs and deliver the target margin.

The balance sheet (statement of financial position)

The balance sheet is a snapshot of financial position at a specific date. It presents assets (what the business owns or is owed), liabilities (what it owes) and the resulting equity. The accounting equation — Assets = Liabilities + Equity — must always hold. The balance sheet supports assessment of capital structure, gearing and liquidity.

The cash flow statement and how the three statements connect

The cash flow statement reconciles opening and closing cash balances, categorising movements as operating, investing or financing activities. It is purely cash-based, making it the clearest indicator of whether the business can meet its obligations. The three statements are interconnected: net profit increases retained earnings on the balance sheet; non-cash charges are added back in operating cash flow; and working capital movements flow into operating cash flow.

Relevant RICS guidance and legislation

  • Companies Act 2006, Part 15 — requires UK companies to prepare and file annual accounts giving a true and fair view.
  • FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland (Financial Reporting Council) — the primary standard for most UK surveying practices and their clients.
  • International Financial Reporting Standards (IFRS) as adopted in the UK — required for UK-listed companies; includes IAS 1 (Presentation of Financial Statements), IAS 7 (Statement of Cash Flows) and IAS 40 (Investment Property).
  • RICS Rules of Conduct (effective 2 February 2022) — Rule 2 (competence) requires members advising on property matters informed by financial statements to have sufficient literacy to interpret those statements accurately.

Ethics and Rules of Conduct angle

Rule 1 of the RICS Rules of Conduct (honesty and integrity) requires advice that is straightforward and transparent. A surveyor who advises on a property transaction without reading the client's financial statements, or who ignores material information such as a going-concern qualification or a large contingent liability, risks providing incomplete advice that fails the client and breaches Rule 2 (competence).

APC-style Q&As

Q (Level 1)What are the three primary financial statements and what does each one show?

The profit and loss account (or income statement) shows revenue, costs and profit or loss over a period. The balance sheet (statement of financial position) shows assets, liabilities and equity at a specific date. The cash flow statement shows cash inflows and outflows classified as operating, investing and financing activities.

Q (Level 1)What is the accounting equation, and where does it appear in the financial statements?

The accounting equation is: Assets = Liabilities + Equity. It is the structural principle underpinning the balance sheet: total assets must always equal the sum of total liabilities and shareholders' equity. If they do not balance, there has been an error in the preparation of the accounts.

Q (Level 2)How are the three financial statements connected to each other?

Net profit from the P&L increases retained earnings within equity on the balance sheet. Non-cash charges such as depreciation are added back in operating cash flow because they are not cash outflows. Working capital movements — debtors, creditors, WIP — appear as further adjustments in operating cash flow. The three statements together form a single integrated picture of performance, position and liquidity.

Q (Level 2)A property investment client's annual accounts include a going-concern qualification in the auditor's report. What does this mean and how does it affect your advice?

A going-concern qualification means the auditor has concluded there is material uncertainty about whether the business will continue trading for at least 12 months, typically due to covenant breaches, refinancing risk or persistent losses. This must inform any property advice: a recommendation to acquire or commit to a new lease could be flawed if the client faces failure. I would disclose the risk explicitly in written advice and recommend specialist financial and legal guidance.

Q (Level 3)You are advising a pension fund on acquiring an office building let to a single tenant. The tenant provides its latest accounts: modest profit, consistently negative operating cash flow and a heavily geared balance sheet. How does this affect your advice?

(example) This combination suggests a stressed tenant. Modest profit with negative operating cash flow indicates earnings are not converting to cash, possibly due to deteriorating debtors; high gearing limits capacity to absorb shocks. I would advise the fund that the covenant carries elevated risk, reflected in an increased initial yield. I would recommend a lawyers' covenant review, examination of any guarantee or rent deposit, and an assessment of void period and re-letting costs. The asset may be viable at the right price, but the client must understand the risk.