Three Statement Financial Model

Three-Statement Financial Model Overview

Definition:

• A three-statement financial model integrates income statements, balance sheets, and cash flow statements, forming the basis for advanced financial modeling like merger models, DCF models, and LBO models.

Core Elements:

1. Income Statement:

   • Depicts profitability, showcasing historical results and forecasts. Revenue forecasting precedes expense forecasting, determining earnings per share and overall income.

2. Balance Sheet:

   • Presents a snapshot of an organization's assets, resources, shareholder equity, and liabilities post-reporting period. Driven by revenue assumptions derived from the income statement.

3. Cash Flow Statement:

   • Demonstrates cash movement into and out of the company. It reconciles changes in the balance sheet, referencing individual line items from elsewhere in the financial model.

   • Forecasting involves creating a cash flow proof using the change between current and forecasted balance sheet accounts. The resulting cash flow statement should reconcile with the forecasted cash balance on the balance sheet.

Data Gathering:

• Essential data is sourced from SEC filings, equity research reports, and press releases, varying in accessibility for private companies and under differing international financial reporting standards.

Model Functionality:

• Modification of assumptions within the model demonstrates interconnectedness between various sections, enabling a holistic understanding of their influence on each other.

Financial Forecasting Process:

• Forecasting typically commences with revenue projection, followed by expense estimations that eventually determine the company's earnings and overall financial outlook.

Steps to Build a Three-Statement Financial Model:

1. Enter Historical Financial Data: Input historical data into an Excel-formatted platform.

2. Define Predictions: Establish predictions driving the forecasting process.

3. Predict Income Statement: Forecast income based on historical trends and assumptions.

4. Predict Capital Investments: Estimate capital investments and asset changes.

5. Predict Financing Activity: Forecast financing activities impacting the balance sheet.

6. Predict Balance Sheet: Formulate the balance sheet driven by revenue assumptions and operating forecasts.

7. Complete Cash Flow Statement: Generate a forecasted cash flow statement reconciling changes in the balance sheet, ensuring alignment with forecasted cash balances.

This seven-step approach provides a comprehensive methodology for constructing a three-statement financial model, outlining the sequential process involved in establishing a robust financial forecasting model.