Financial Modeling Three Statement Model – Three Financial Statements

Financial modeling is not as easy as it sounds. It takes a lot of time, experience, and a sufficient industry know-how to create a model. There are structures which one can use to create a financial model and of it is a more complex financial model and widely used for businesses that requires a lot of details and analysis – Three Statement Model.

The term Three Statement Model refers to the three financial statements that you know of in Accounting:

• Income Statement

• Balance Sheet

• Cash Flow Statement

These three financial statements are used as the base report for the Three Statement Model. By using these three financial statements, you will be able to create a more precise model of a business’ or an asset’s future financial projections. 

Here is the normal model structure of a Three Statement Model:

1. Assumptions – usually stated in the Executive Summary where it shows the estimate to revenues, costs, schedule of payments received and issued, assumptions regarding investments either for business development or fixed assets as well as taxes, depreciation, and interest rates.

2. Operating Model – a visual report of how the business delivers value in different aspects as well as checking the changes or possible changes that will happen to the business, the model also represents as a report on how the business operate in present and in the future. 

3. Operating Ratios – are used to determine whether the expenses or assets used to operate the business is within the limit of the business’ capability and reasonable enough to help the business grow and operate normally. The ratios will vary from model to model depending on the three financial statements of the business.

4. Fixed Asset Schedule – all detailed assets of a business will go through depreciation or amortization where a part of the assets’ value will be expensed, hence, this section is an expense projection of assets and also serves as a tracker of each individual asset and its related depreciation or amortization.

5. Debt Schedule – it is important to anticipate the timing of every repayment to keep track of every cash flow in the business, so a debt schedule is needed to be include this in the model.

6. Three Financial Statements – the core of every financial models, without these three, it will be difficult to complete a financial model of any business since every report serves it purpose and makes it easier for any financial modeler or analyst to calculate any projections about the business.

7. Financial ratios – very helpful component of the model which makes it possible to see a business from a different perspective. The usual important ratios are Financial Debt/ EBITDA, Current Ratio, ROIC, etc.

8. DCF or IRR Analysis – to complete the model, an analysis or valuation is made to determine the value of a business, whether it’s doing good financially or not. This will also help the interested party to better understand the business and to come up with good economic decisions in preparation for the future.

Though it is easier to create a simpler financial model structure which doesn’t require a lot of processes to determine a business’ or asset’s financial performance, having a more sophisticated financial model is preferable due to how thorough the information will be shown in the report. To learn more about the Three Statement Model and to see an example of its structure, you can see the full article here about the Two Basic Structures of Financial Models.