MODEL YOUR FUTURE - THE BRIXX BLOG
How To Use A 3-Statement Financial Model To Grow Your Business
A 3-Statement Financial Model is, in essence, a reflection of the three key financial statements. Accounting, on the one hand, allows for the understanding of a company’s historical financial statements. On the other, forecasting those statements allows for the exploration of how it will perform under a variety of different assumptions and visualise how its decisions impact the future bottom line.
An effective 3-Statement Financial Model is a dynamic combination of:
- Profit and Loss Statement – the earnings and the profitability of a company for a specific period.
- Balance Sheet – a snapshot at any particular time to show assets, liabilities, and equity.
- Cash Flow Statement– an illustration of the inflows and outflows of cash at a specific period of time.
Our Guide To Successfully Planning Business Growth Using A 3-Way Forecast takes you through the basics of 3-Statement Financial Models.
Let’s talk about the 3-Statement Financial Model
- The basics of a 3-Statement Financial Model
- Using 3-Statement Financial Models to plan for growth
- The layout and structure of an effective 3-Statement Financial Model
The basics of a 3-Statement Financial Model
3-Statement Financial Models are the foundation on which advanced financial models are built. Combining the three key financial statements makes it easier to navigate, there is less risk of mis-linking formulas, there is more organisation, and it allows more room for consolidation.
In order to create an effective 3-Statement Financial Model, one would need to be able to input historical financial information, determine the assumptions that will drive the forecast, forecast the income statement, forecast capital assets, forecast financing activity, forecast the balance sheet, and complete the cash flow statement. We go into how to create a 3-Statement Model in our Guide To Successfully Planning Business Growth Using A 3-Way Forecast.
Using 3-Statement Financial Models to plan for growth
Once a company has created a 3-Statement Financial Model, it can leverage the information contained within it to create multiple budgets. This will allow them to model multiple scenarios and compare a number of 3-Way Forecasts to plan for a multitude of potential situations. This not only helps plan for growth but aids in avoiding situations that may derail the company’s trajectory.
There are a number of advantages to using a 3-Statement Financial Model to perform scenario analysis. These include, but are not limited to, gaining the ability to plan for the future, becoming proactive, avoiding risk and failure, and projecting returns and losses. However, conducting scenario analysis requires a high level of skill and one cannot predict unforeseen outcomes or model every single scenario. But by modelling, at the very least, the best case, worst case, and base case scenarios, one can gain valuable insight to drive business decisions.
Not only can a 3-Statement Financial Model help you know your financial standing and plan for the future but effective forecasting in business has a number of other benefits, including enabling businesses to:
- Be effective when seeking funding
- Set clear goals and plan ahead to reach them
- Create clear and accurate budgets
- Anticipate changes within the market
Financial forecasts are key for any business, no matter its size. And in recent years, the 3-Way Forecast, or 3-Statement Financial Model, has become essential. Our free Forecasting Fundamentals Guide will take you through the ins and outs of financial forecasting and its importance in business.
Creating a 3-Statement Model for purpose
When deciding to make a 3-Statement Financial Model, you’ll need to know which period you’re going to be modelling for. This could be annually, quarterly, monthly, or weekly and will be determined by the purpose of your model.
This period is common when looking to use the model to drive DCF model valuations. This is because there needs to be at least 5 years of forecasts before making a terminal value. LBO models are often also annual. A DCF model simply refers to Discounted Cash Flow and is a forecast of a company’s free cash flow, discounted back to today’s value. A LBO model refers to an evaluation of a leveraged buyout transaction, where someone purchases a company using almost entirely debt.
A quarterly period is generally used for a number of purposes and are often rolled up into an annual buildup. These purposes could include:
- Equity research
- Financial planning and analysis
- Mergers and acquisitions
- and more
This type of period is common when looking at restructuring and project finance. Anywhere where month-to-month liquidity tracking is key. These often roll up into a quarterly buildup.
The most common weekly model is the “13-week cash flow model” (or TWCF). It is required for the bankruptcy process to track cash and liquidity. Bankruptcy is the most common reason for a weekly model.
The layout and structure of an effective 3-Statement Financial Model
There are two typical approaches to creating a 3-Statement Model. They are single-worksheet and multi-worksheet layouts. Depending on your needs and unique company structure, you may prefer one over the other. However, we recommend a single-worksheet layout if possible as they are easier to navigate and there is less risk of formula errors.
A complex financial model like this, if you plan on creating your own, should adhere to a consistent set of best practices. This will make modelling and auditing tasks easier and more transparent.
Basic 3-Statement Model formatting best practices
Colour coding inputs, formulas, outputs, etc. can help you more easily navigate your sheet. While the standard colours are blue, black, and red, respectively, we won’t judge if you decide on another colour scheme.
Keep formats consistent throughout. This could be keeping a consistent unit scale, standard decimal placings, etc.
Avoiding hard numbers
- Avoid partial inputs that commingle cell references with hard numbers.
It may seem simple but standardising your column width and consistent header labels can make all the difference.
Adhering to a strict structure
When models get large, you should keep a strict structure in place.
- Use roll-forward schedules when forecasting balance sheet
- Aggregate inputs in one worksheet (or one section of the model) and separate them from calculations and outputs
- Avoid linking files together
Automating the 3-Statement Model
While many still adhere to traditional means of creating a 3-Statement Financial Model, there are many benefits to automating this report through specialised solutions.
When you switch from a manual process to an automated one, it can save a lot of time. Removing a particularly heavy part of the workload can shift valuable resources to the strategic development of the company.
Automation enables robust accuracy, where any issues can be identified, analysed, and improved more easily. It helps ensure the forecast is informed by all relevant data sources and that errors are kept to a minimum.
By automating the process, it greatly reduces the risk of human error. This helps promote the reliability of the forecast.
Specialised tools like Brixx exist to automate the 3-Statement Financial Model process for you. Brixx offers a free version called Brixx Foundations as well as a number of templates and guides on financial forecasting and management on the website. We can help you set up a well-designed forecast which allows for sensitivities and different scenarios to be modelled. This can help you see how a change in assumptions impacts your company’s future financial position.
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