Creating a Three Statement Model in 7 Easy Steps

A three-statement model is a sophisticated financial model that includes the three important financial statements—the income statement, the balance sheet, and the cash flow statement—and incorporates them all into a single financial model. Further important models, such as DCF valuation, merger and acquisition models, etc., are built on top of this model. Additionally, the three-statement model is employed in sensitivity and scenario analysis. The greatest benefit of these models is that they allow us to simultaneously record the foundations of three statements in a single excel file.

 

A guide to creating a three-statement model

 

The likelihood of incorrect formula linkages is reduced. Instead of having three different models, it looks more structured when everything is displayed in a single excel file. Additionally, it gives multi-business enterprises a wider range of consolidation options.

 

Relationship Between Three Statements

 

The Balance Sheet

 

The balance sheet of an organization, often known as the statement of financial position, offers details on the company’s book value. The balance sheet, which is divided into three sections, summarises the company’s assets, liabilities, and shareholder’s equity as of a particular date. The balance sheet may typically be thoroughly examined to provide several fast perspectives.

 

Assets must equal liabilities + equity for the balance sheet to “balance.” According to analysts, the book value or equity of the company equals its assets less its liabilities. In certain circumstances, analysts may additionally consider the firm’s total capital, which combines an analysis of the equity and liabilities.

 

Numerous ratios can be used by analysts to evaluate the effectiveness of a company’s balance sheet. The most used metrics are asset turnover, quick ratio, receivables turnover, days to sales, debt to assets, and equity debt.

 

The Income Statement

 

The income statement of a business gives information on the revenue it brings in and the costs associated with its daily operations. Overall, it offers fine data on a company’s overall operating activities. The income statement, in general, displays the direct, indirect, and capital expenses of a business.

 

The gross profit margin of a corporation is then frequently calculated by comparing the gross profit to the total sales. The income statement also includes essential indirect charges. The second category, referred to as indirect expenses, includes all fees that are unintentionally incurred by a company while it is engaging in activities that generate income.

 

These expenses might cover salaries, general and administrative costs, R&D, depreciation, and amortization. Operating income is calculated by deducting the sum of these indirect costs from gross profit. Capital expenses are included in the last category on the income statement. Interest, tax, and unusual items should be the final costs taken into account.

 

The net income, or overall amount of earnings a company has realized, is obtained by deducting these items. The income statement, which provides a lot of information on the business’ operating activities, also significantly influences the other two financial statements.

 

Retained earnings, or net income after a period, are added to the stockholders’ equity of the corporation. As accounts receivable, sales that were made during the period are also included in the company’s short-term assets. Analysts often examine a company’s profitability on the income statement.

 

Read here the Basics of Finacial Modeling

 

The Cash Flow Statement

 

An overview of a company’s entire liquidity is provided by the cash flow statement. The entire amount of cash available is reported along with the sum of all cash inflows and outflows throughout the course of an accounting period. The operating, Investing, and Financing sections make up a typical cash flow statement. This financial statement shows the net changes in total cash for each of these three categories.

 

The cash received from sales made during that time is shown in the operating component. The operating cash outflows used to make those sales are also shown. For instance, the money used to pay for rent, salaries, and other expenses. Investment and finance are the other two sections of the cash flow statement that are directly related to the firm’s capital planning, which is connected to the liabilities and equity on the balance sheet.

 

Cash-related asset-focused activities such as asset purchases and asset gains from invested assets are the main focus of investing activities. Capital structure finance is the main focus of financing cash operations, including cash payments for obligations like interest and dividends. Proceeds from the issue of debt and shares are also shown.

 

The Whole Picture

 

For a thorough knowledge and analysis of a company’s performance from many perspectives, all three accounting statements are crucial. The income statement gives detailed information about the main business operations that provide profits for the company. The management of the firm’s capital in terms of assets and structure, however, is more the emphasis of the balance sheet and cash flow statement.

 

Overall, top-performing businesses will score highly in areas including capital structuring, asset management, and operational efficiency. The interrelated reporting of these three levers is what makes financial statement reporting so crucial because management is accountable for managing them in a way that serves the interests of the shareholders.

 

Also Read: Types of Financial Models

 

Important Points to Remember Before Creating a Three-statement Model

 

1. Excel Layout for Financial Modeling

When creating a financial model, it is best to pay attention to three key factors: formatting, periodicity, and the structure of the financial model. There is a great deal of significance in each of these.

 

2. Format

As far as the three-statement model structure is concerned, make sure you adhere to the rules. Try not to create too many variations. To make your financial model simpler to understand, use a standard color scheme throughout. Setting separate your inputs, calculations, and connections will become challenging if you stick to a single color scheme. Additionally, be sure your data format is consistent.

 

3. Periodicity

Periodicity comes after that. This basically refers to the division of your financial model into phases. Annual, quarterly, monthly, and weekly are the four options that you will find here. When developing a three-statement model, you can employ any of these variations. The annual cycle is, however, always taken into account when it comes to presentation.

 

The other approaches allow you to learn more about how things work. Calculating the Discounted Cash Flow (DCF) value is one of the yearly variation’s most popular uses. To determine where the business will be at a certain point in time, yearly cash flows are taken. Additionally, quarterly and monthly financial models with three statements gradually become annual ones. The weekly one is used to monitor the business’s liquidity and cash flow.

 

4. Structure

You should make sure you’re adhering to a specific framework when it comes to the financial modeling excel structure now. In particular, it applies to complex three-statement financial models. A random financial model is not what you desire. It will be challenging for you to comprehend and will turn off any possible investors.

 

To make it simpler for you to understand every element of the financial model, make sure your assumptions or inputs are on a different sheet. Additionally, you should watch your linking of files to make sure you’re not overdoing it. It would become challenging to track all the data entering your financial modeling if you shift your financial model between different devices.

 

Here are the excellent Online Financial Modeling Courses to learn the different types of financial models

 

Steps to Create a Three-statement Model

 

Step 1: Obtaining or Compiling Historical Information from Financial Statements into a Single Excel File

 

In this step, financial details are gleaned from the company website or a press release, which are both regarded as historical data. One of two methods is used to enter the data: copy-pasting or downloading it to a single excel file. In order to make the data clear and understood after doing this, the excel file needs to be formatted a little.

 

Step 2: Making Assumptions That Will Affect Forecasting

 

Once the historical data has been entered into our excel file, certain formulas are used to determine or assess the past performance of the business. The following metrics can be taken into consideration: working capital calculation, margins, revenue growth, and capital expenditures.

 

Step 3 – Budgeting for the Income Statement

 

It is now time to forecast the income statement after taking all of the assumptions into account. Everything starts with the revenue and moves on to the EBITDA calculation. It can be done with the support of scheduling techniques for capital assets and financing activity processes at this level.

 

Here is a comprehensive guide to DCF Financial Modeling

 

Step 4 – Forecasting Financial Assets

 

Forecasts are created here for things like property and plant and machinery, and only then can the model’s income statement portion be finished. Here, the final closing balance is calculated by first taking into account the closing balance from the previous period, to which the capital expenditure is then added or the depreciation is subtracted.

 

Step 5 – Prediction of Financial Activity

 

To get the interest expense on the income statement, draw up a schedule of debt plans in this case. the closing amount from the previous period is taken into account and then added with any rise or fall in the principal’s value to arrive at the closing balance.

 

Step 6 – Forecasting the Balance Sheet

 

Here, balance sheet data and working capital components are anticipated while taking into account various hypotheses, like average payable days, average receivables, average inventory turns, etc. The schedule that was discussed earlier is where the capital assets originate from. The third and final stage of the model is not completed or forecasted in this instance.

 

Step 7 – Finishing Up the Cash Flow Statement

 

Finishing the cash flow is the final step in making a model. In order to determine the cash balance for this statement, it is just necessary to link the prior items together. There are three basic divisions: cash from operations; cash from investment activity; and cash from financing activity. The ultimate cash on hand/bank is balanced by connecting these three to the other figures.

 

You can also check out the most sought-after Financial Modeling Courses in India

 

A three-Statement Model Excel Analysis

 

You must make sure that as you develop your financial model, tests and analyses are done to determine its efficacy. If you want to be sure that your integrated model is constructed correctly, you need to do two main studies.

 

Sensitivity Analysis

 

The sensitivity analysis concentrates on one financial model output and how one or two associated inputs impact it—observing the EPS changes while adjusting the sales growth or margins. You may be sure you’ve constructed a solid financial model if your financial model enables you to make these adjustments and observe the desired results.

 

Scenario Analysis

 

Scenario analysis is another widely utilized type of study. Here, you will put numerous financial, operational, or investing hypotheses to the test that could affect the result. Once you’ve finished making your basic model, you do this. As it comes to a finish, you can test how various hypotheses will affect your outcomes.

 

FAQS

 

What value does creating integrated financial statements have?

An integrated model is effective because it allows the user to alter an assumption in one area of the model and observe how that alteration affects all other areas of the model uniformly and precisely.

 

How important are financial statements?

Financial statements give a quick overview of a company’s financial situation and include information on its operations, profitability, and cash flow. Financial statements are crucial since they reveal details about a company’s income, costs, profitability, and debt.

 

What are the applications for financial statements?

Giving information about an organization’s financial situation, operating outcomes, and cash flows is the main goal of financial statements. The viewers of financial accounts make decisions about the distribution of resources using this data.

 

Conclusion

 

So, a three-statement model or an integrated financial model is used to predict or project the financial status of an entire business. It includes the three interconnected financial statements: the cash flow statement, the income statement, and the balance sheet. The model is connecting three important financial statements, such as the income, balance sheet, and cash flow statement, and creates a single, dynamically connected financial model that serves as the foundation for more complex financial models, such as leverage buyout and discounted cash.

 

A company’s operations in the past, present, and anticipated future are represented in numbers through financial modeling. These models are meant to be used as instruments for making decisions. Executives of the company may use them to project the expenses and revenues of a proposed new project. Financial modeling is crucial for a variety of reasons, but it’s most significant for decisions involving mergers and acquisitions, capital raising, corporate planning and management, and investment choices.

 

As a startup, there are a lot of benefits to having a financial model. Because by measuring (and then evaluating) your business strategy, business model, assumptions, and vision, you can determine whether you can turn your ideas into an operational business that can last a long time. Hope this article was informative. Happy reading.

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