We know that correct data and adequately interpreted and analysed information are crucial for making informed business decisions. Misinterpretation of data can cause dearly to a business.
Using the three-statement financial model including cash flow statement, income statement and balance sheet helps in understanding a business’s present and future financial position. Taking up a suitable banking and finance course is helpful if you are interested in a career in banking and finance.
Aspirants looking to make a career in investment banking or banking and finance should be proficient in building three-statement financial models. Investment banking associates or analysts will need this skill to meet their daily responsibilities.
What Is the Three-Statement Model?
Almost all standard banking courses, including an investment banking course, cover the three-statement model in their curriculum.
A three-statement model is an integrated financial model, which helps predict a business’s balance sheets, income statements and cash flow statements. These three core elements are integrated into a single financial model.
The three-statement model acts as a foundation for other critical models like merger and acquisitions models, DCF valuation models, leveraged buyout models (LBO) and so on. This model is also extensively used for sensitivity and scenario analysis.
The greatest benefit of this three-statement model is that it captures the basics of all three statements (income statement, cash flow statement and balance sheets) in a single Excel file. Since the whole thing is present in a single Excel file, it looks highly organised.
Moreover, there are minimal risks of wrong formula linkages. There is no need to use three different models. For multi-business organisations, the three-statement model offers great scope for consolidation.
Core Elements of the Three-Statement Financial Model
A three-statement financial model includes different schedules and outputs. However, the below-mentioned elements are considered as the core elements of the three-statement financial model.
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Income Statement
A business’s profitability is usually depicted through the income statement. The format of these statements is generally from left to right. The statements include historical results of not less than three years. Analysts can calculate growth rates and historical ratios.
The first step in creating a three-statement financial model is to input data from historical income statements. The data input process can be manual or via an Excel plugin.
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Balance Sheet
The balance sheet provides a snapshot of a company’s operations after a specific reporting period. The balance sheet displays the assets and resources of the business along with the funding sources of the resources like the liabilities and equity of a shareholder.
Revenues drive the operating assumptions. These assumptions drive the balance sheet based on the income statement.
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Cash Flow Statement
The final core element of the three-statement financial model is the cash flow statement. There is no use in entering any kind of results from historical cash flow statements before forecasting. This is because of the reconciliation of balance sheet changes from the cash flow statement.
Every item in the cash flow statement should be duly referenced from proper sources within the financial model. When the cash flow statement is proper, the balance sheet remains perfectly balanced. For generating a forecasted cash flow statement, you will need cash flow evidence.
Planning for Business Growth With the Three-Statement Financial Model
Once a business creates a three-statement financial model, it can use the information in the model to create numerous budgets. This gives businesses the scope to model myriad scenarios. Moreover, organisations work on three-way forecasts so that they have plans ready for different potential situations.
Along with planning for the growth of the organisation, the three-statement financial model helps in keeping situations at bay which might hamper the operations and progress of the company.
There are innumerable advantages of using the three-statement financial model for scenario analysis. Some of them are as follows:
- Helps in becoming proactive
- Helps in planning for the future of the business well
- Helps in projecting returns and losses in the business
- Helps in avoiding risks and failures in business
- Helps in gaining valuable insights for driving business decisions
- Helps in knowing the current financial standing of the business
- Helps businesses to be effective while seeking funding
- Helps in creating accurate and clear budgets
- Helps in setting clear and realistic goals and plan accordingly to achieve them
- Helps in anticipating the changes that take place in the market
Whatever the size and volume of your business, financial forecasts are mandatory. With the three-statement financial model in place, financial forecasting has become simpler, more efficient and more accurate.
7 Easy Steps To Create a Three-Statement Financial Model
Financial experts and industry leaders in this field often debate the number of steps that are required to create a three-statement financial model. While some say five steps are sufficient; others say that seven steps are needed for a three-statement financial model.
These are the 7 steps that you must follow to create a three-statement financial model:
- In an Excel-formatted platform, enter historical financial data (manually or with an Excel plugin)
- Define the predictions driving forecasting
- Forecast the income statement
- Predict assets and capital investments
- Forecast financing activity
- Forecast the balance sheet
- Finish with the cash flow statement
Conclusion
The three-statement financial model is dynamic as it integrates all the crucial financial statements into one Excel file. With reduced human errors, the work becomes highly organised and efficient. It is one of the best financial models for forecasting modules. Based on MS Excel, the three-statement financial model is extremely user-friendly as well.
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