Introduction
The 3 statement model in financial modelling integrates three core financial statements: the income statement, the balance sheet, and the cash flow statement. These statements are used to forecast how well the business is performing by using various assumptions.
These statements collectively include the company’s revenue, expenses, debt, equity, cash, & cash flow over time. The 3-statement financial model acts as a base for various other advanced models such as the DCF model, M&A model, financial analysis, etc. It is built by first entering and analysing historical results.
Such models act as powerful tools for the company as they allow it to modify assumptions on one part of the model to check how accurately it influences the other areas of the models.
Elements of 3-Statement Financial model?
There are 3 core elements of the 3-Statement Financial model.
1. Income statement
This statement gives a detailed analysis of the financial performance of the business using a formula which is,
Revenue – Expenses = Net income
It depicts business profitability and influences further statements, such as balance sheets and cash flow. The income statement is produced for a specific period, say quarterly or annually, and follows the accounting principles.
To create the 3-statement financial model, we need to input the historical data of the income statement as the first step.
2. Balance sheet
The balance sheet includes assets, liabilities, equity and debt. It acts as the snapshot of the company after any given reporting period. The balance sheet is created for a specific date and not for any particular period and displays the operating results over a specified time.
Revenue derives from the operating assumptions which drive the balance sheet made based on the income statement.
3. Cash flow statement
The last core element of the 3 statement financial model is the cash flow statement. This statement records and analyses the inflow and outflow of the cash in the company.
The statement includes three categories, which are,
- Cash from Operating activities – Inflow and outflow of cash in the day-to-day operations such as inventory, payroll processing, customer payments, etc.
- Cash from Financial activities – Inflow and outflow of cash by raising capital, issuing debt or equity etc.
- Cash from Investing activities – Inflow and Outflow of cash from either the purchase or sale of an asset is considered under investing activities.
How to build a 3-Statement Financial model?
There are a few easy steps to half a three-statement financial model, which include;
- Incorporating historical data
To start building a financial model, you need to start by collecting the data and input the financial information into Excel. Finding data from our own company is a lot easier than finding the data of another company. And it becomes a lot harder when it comes to private companies as the data is not available in public. Once you find the data, paste it into Excel and format and organise the data, particularly the income statement, balance sheet, and cash flow statement. - Laying out assumptions to guide the model
Assumptions act as your model drivers, helping you build the model successfully. You can predict growth, working capital, expenses, capital expenditures, depreciation, and financing. These drivers will help you build a realistic financial model and analyse your financial performance better.
- Predicting the income statement
Forecast the revenue four to five periods out using the assumed growth rate as per the preference. You need to do the same for all the other line items except depreciation, amortization, and interest expense.
- Predicting the long-term capital assets
Capital assets and debt play a prominent role in building the financial model as it helps to calculate the interest, depreciation and amortization expenses. Now create a debt schedule using the existing debt and add the additional debt capital you expect to raise during a specific period.
- Preciting financing activity
Forecast the upcoming financing activities which will include your debt & equity. Include dividends, interest, issuing and raising further capital etc. - Completing the statements
Now finish all three financial statements. Start with the income statement. Add the depreciation and interest expands calculated in capital assets and debt schedules to the income statement. Calculate the tax and net income.
Finalize the balance sheet by inserting the capital assets and debt figures from the created schedules. Calculate working capital by using the assumptions.
Finally, finish the cash flow statement, which includes the three important sections: cash from operating activities, cash from investing activities, and cash from financing activities. Grab the information required from the income statement and the balance sheet.
Bottom line
The 3-statement financial model is a great tool for making informed decisions, forecasting, cash management and assessing financial performance. It helps you generate a clearer understanding of the company’s finances.
With FinnovationZ courses on financial modelling, you can easily understand financial modelling from its base and the tools will allow you to quickly analyse the financial performance and impact of your decision on your business.