This 3-statement model template combines three key reports:
Income statement: A cornerstone of many financial models, the income statement reveals the business's ability to make a profit (and the extent of that profit).
Balance sheet: When paired with the profit and loss statement, the balance sheet shows how much cash or investment you need to support the sales and profits on the income statement.
Net income from the income statement flows into the balance sheet as a change in retained earnings (adjusted for payment of dividends).
Cash flow: This statement displays the change in cash over a period along with both the beginning and ending balances for that period in cash.
Your cash flow statement takes net income and adjusts it for any non-cash expenses. From there, you can reference changes in the balance sheet to find cash usage and receipt patterns.
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Step 1: Open the template in Excel or Sheets.
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All About the Basic 3-Statement Model
A three-way forecast, also known as the three-statement model, uses assumptions, drivers, and information relevant to a modeler’s business to quickly produce a single consolidated forecast with projections for all three financial statements.
It links your profit & loss (income statement), balance sheet, and cash flow projections together so you can forecast your future cash position and financial health.
For this reason, a three-statement model is the best way to provide granular financial forecasts that explain the future perspective of your business from multiple angles (Revenue growth, profitability, capital needs, cash burn).
Today we’ll cover the essentials of the three-statement model. You’ll learn:
- An explanation of the basic financial statements
- How the 3-statement model is prepared
- How is the 3-statement model linked?
- The importance and use of the 3-statement financial model
As an Excel model, the three-statement model is easy to manipulate and learn how to use.
What are the three financial statements?
Financial statements report on a company's financial performance over a given period. They include information about the company's historical financial data, capital expenditures, debt balances, working capital items, revenue growth, net income, expenses, cash flow, and other historical information necessary to build financial models.
Organizations use the three-statement financial reporting framework. This consists of three pro forma documents prepared using all available financial data. In the case of publicly traded companies, financial statements are subject to periodic review and audit to ensure accuracy for shareholders.
The three financial statements are the company's income statement, the balance sheet, and the cash flow statement (sometimes called the statement of cash flows).
Let’s go into more detail on each component of the 3-statement financial model.
The income statement is the most important of the three financial statements. The income statement reports all business operations for the period in review. It gives the reader a summary of all cash (revenue) coming into the business and the cash spent to earn that revenue. It shows whether the business can profit and how much it could be.
Read the income statement from top to bottom. It starts with the total revenues earned over the period. Below it shows the expenses:
Direct: Costs that can be tied to a product or project. This is reflected in the Cost of Goods Sold (COGS). These costs are then taken out of revenue to show a gross profit.
Indirect: Overhead costs that can’t be tied to a specific project but contribute to generating revenue. These include wages, administrative costs, R&D, asset depreciation, and loan amortization.
The income statement also shows operating and non-operating expenses like interest expenses, as calculated by the debt schedule.
After deducting total expenses and tax, you’re left with net earnings.
The balance sheet shows how much cash (or cash equivalents) is needed to support sales and profits shown on the income statement.
The balance sheet shows what the company “owns and owes,” meaning all the assets, liabilities, and shareholder equity reported for a specific period. It can be used to calculate the rate of return on investment and examine the company’s capital structure.
Some sample balance sheet items are the company's long-term debt, the accounts payable, wages payable, the average balance of debt outstanding, cash, accounts receivable, and long-term assets like PP&E (property, plant, and equipment).
The balance sheet also contains information about shareholders' equity. Sometimes, this information may be broken out into separate reports.
Cash Flow Statement
The cash flow statement reports all the movement of cash (and cash equivalents) into and out of the company. This statement shows the organization's cash management and its operations' health. It also reveals the company’s liquidity—the funds it has to run the daily operations and pay off liabilities.
The statement of cash flows will also show free cash flow, or how much cash a company has after paying the costs to keep the business running (operating expenses and capital expenditures).
How is the 3-statement model prepared?
Finance builds the three statements in a specific order to show activity for a specific period. This is because pieces of data on one statement carry over to lines in the other two. For instance, month-end financial reports are compiled after the completion of month-end closing activities and proceed as follows:
Prepare the trial balance
A trial balance account lists all the ending balances in your general ledger accounts. This is an internal report used to start the reporting process. After the trial balance is calculated, accounting makes adjustments to account for differences due to accruals.
Make adjusting entries
Once your trial balance is complete and accurate, the accounting team will make adjusting entries to bring balances up to date. For instance, if you owe paychecks to employees but they haven’t been paid out yet, an adjustment debiting your wage expense and crediting your wages payable will bring that account into balance.
Adjust the trial balance
As with the unadjusted trial balance, list the accounts and their ending balances. This time, the balances will reflect the adjustments made in the previous step. Entering the adjusted trial balance ensures that the figures appearing in your financial reports are accurate.
From this point, you can compile the financial statements with certainty that your adjusted balances on the income statement are accurate. It’s important to ensure accuracy with these early steps since errors in the income statement will flow through to the other two statements.
How is the 3-statement model linked?
Each financial statement is linked together with data from one report supporting the data on the other two. Income statement line items that link to the balance sheet and cash flow statement include:
- Net income: The bottom calculation from the income statement appears on the balance sheet and cash flow statement.
- Depreciation: Added back into cash flow statement.
- Capital expenditure: deducted from the cash flow statement, which determines the amount for PP&E on the balance sheet.
- Financing: Feature on the balance sheet. Cash from financing also appears on the balance sheet.
- Cash balance: Closing cash balance from the previous period, added to the current period cash from operating activities, investing, and financing, becomes the closing cash balance on the balance sheet.
Why is the three-statement financial model important?
Financial reporting provides your stakeholders with needed information to evaluate the company’s financial health. It also empowers decision-making by providing easy access to the most valuable data in easy-to-read reports. The financial statements provide information for several internal and external purposes:
Financial ratios: The figures in your financial statements will provide the data necessary to calculate numerous financial ratios.
Forecasting: Accurate financial statements are used in financial forecasting and financial modeling, using the historical data contained in previous statements to act as a source of truth for making future assumptions and predictions.
Scenario planning: Financial data from the cash flow statement is used to create scenarios for better decision-making. The information on revenue growth, expenses, and cash flow can be used to adjust product pricing, overhead costs, and other variables to improve financial performance.
Investor relations: Financial statements are often the basis for decision-making on questions of credit and investment. By showing strong financials, your company will have access to lines of credit. It will be easier to attract interest from investors. In publicly traded companies, financial statements are required to show shareholders the financial position of the company.
A solid understanding of financial modeling (like the three-statement financial model) in Excel is essential for people who work in investment banking.
Examples of industry-specific applications
These industry-specific examples illustrate the adaptability and precision achievable through a customized three-statement model. Whether in tech, healthcare, or other sectors, this approach proves instrumental in navigating the unique landscapes of varied industries.
Real Estate: Customize the three-statement model for the real estate sector, accounting for property acquisition costs, rental income streams, and the impact of market fluctuations on property values.
Manufacturing: Fine-tune the three-statement model for manufacturing, addressing inventory turnover, production cycles, and specific metrics like cost of goods sold (COGS).
Software Development: Tailor the three-statement model for software companies, considering recurring revenue, R&D expenses, and agile financial planning in the fast-paced tech industry.
Healthcare: Tailor the model to healthcare complexities, considering regulatory nuances, varying patient volumes, and significant investments in medical infrastructure.
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