A 3 way financial model, or TFM, is a type of financial forecasting tool used to project a company’s financial performance. 3 Way Financial Models provide a comprehensive view of a company’s past and future performance by incorporating three important aspects of the company’s financial performance: income statement, balance sheet, and cash flow statement. TFM can help business owners and investors make informed decisions when it comes to making wise investments and forecasting future financial performance.
Purposes of 3 Way Financial Models
- Valuate a business
- Forecast a company's future performance
- Project accurate financial statements
- Produce pro forma statements to present to funders.
- Develop dynamic plans and scenarios
- Create adjustable assumptions to customize models to fit specific needs.
- A 3 Way Financial Model can help project future performance with accuracy
- Use TFM to valuate a business and produce pro forma statements
- Develop dynamic plans and scenarios with adjustable assumptions
- A TFM can help make informed decisions when making investments
Benefits of Accurately Selecting a Model
Having a concrete plan for any sort of long-term financial goal is incredibly important. This is especially true when it comes to investments, business plans, and other financial initiatives. Fortunately, when it comes to financial planning, there are a variety of models and approaches that can be used for creating predictions and projections. Having an accurate 3 way financial model can potentially provide a number of significant benefits that could make the whole of process of financial planning easier, more reliable, and ultimately more successful.
Successful Financial Planning
The most obvious benefit of investing in a solid 3 way financial model is that it provides a reliable guide for long-term financial plans. By having a model in place, stakeholders can easily assess their performance, allow for more accurate predictions and revisions, and ensure that all key points, such as profits, budget, and investments, are met. Moreover, the data and insights provided in the model can help stakeholders to predict any potential liquidity issues in advance and make plans accordingly. Ultimately, this can lead to better performance in the financial market.
The 3 way financial model provides critical insights and analytics that can be used to accurately assess the risk and return of a financial plan over a certain period of time. Many models are capable of providing key insights such as break-even points, return on investment (ROI), cash flow analysis, among other elements. Such accurate projections can be incredibly useful for spotting potential opportunities and weaknesses within a plan or investment allotment.
Improved Decision Making
Having a 3 way financial model in place can provide the necessary data and insights needed to make relevant and informed decisions quickly. With the model, it can be easier to assess potential risks and returns while taking into account various scenarios and conditions. This may be especially useful in cases where fast decisions are needed due to changes in market conditions or other external factors. Having such a model can also help to ensure that decisions are based on firm facts and projections, which can generally result in more successful outcomes.
Types of 3 Way Financial Models
There are a variety of approaches to constructing a 3 way financial model. While there are many nuances and details to consider, the three primary types of 3 way financial models include macroeconomic, fixed variables and reverse cash flow analysis models.
A macroeconomic 3 way financial model is a forecasting tool that estimates the effects of an economic decision on an economy by comparing the baseline variables, such as GDP, inflation, and investment, with the projected variables. It then compares the two sets of variables to determine the impact of the proposed decision.
A fixed variables 3 way financial model is designed to assess a model using unrealistically stable variables to ascertain the outcomes under different scenarios, such as hypothetical economic or market shocks. This method is often used to project the effects of drastic changes and provides a good idea of how the business could adjust to them.
Reverse Cash Flow Analysis
The reverse cash flow analysis is a type of 3 way financial model wherein the parameters are reversed from the projected ones to the historical ones. This provides an idea of how an investment or decision would have performed in the past given the same set of inputs. This type of model is often used to analyze the feasibility of a certain project.
When selecting a 3 way financial model, it is important to consider which type of approach best fits the needs of your business. Consider the objectives of the modeling exercise and the data available to ensure that the model chosen will provide the results required.
Choosing the Right 3 Way Financial Model for Your Needs
Choosing the right financial model is an important decision for any business. The 3 way financial modeling tool will provide the foundation for decision making on many levels including capital planning, risk analysis and financial forecasting. It is important to understand your company’s individual needs in order to make the best decision when selecting a 3 way financial model.
4. Criteria for Choosing a Model
When deciding on a 3 way financial model, it is important to consider your goals, resources and the complexity of the model needed.
a. Long-term or Short-term Goals
The first criteria to consider is your long-term or short-term goals. If you are focused on short-term goals, then a simpler model may be enough. On the other hand, if your attention is on the long-term, then a more comprehensive model may be required. Asking yourself what you are ultimately trying to achieve will help you decide the type of model to use.
b. Resources Available to Build Model
The second criterion to consider when choosing a 3 way financial model is the resources available to build the model. If your resources are limited, then you may find benefit from a simpler model that only requires minimal maintenance and enhances real-time performance. If you have ample resources available to build the model, then a more complex model with more features can be considered.
c. Complexity of Model Needed
The third criterion when choosing a 3 way financial model is the complexity of the model needed. If you have a highly complicated project that requires various inputs and outputs, then a more complex model can provide the level of detail and accuracy needed. On the other hand, if the project only requires relatively simple calculations, then a basic model could work.
Understanding the criteria for choosing the right 3 way financial model is the key to making the best decision for your business needs. Taking the time to consider the long-term or short-term goals, resources available to build the model and complexity of the model needed can result in finding a model that provides the most benefit.
Building a Model
Developing and building a 3-way financial model can be a complex and daunting undertaking. Without the appropriate understanding and guidance, the process can be unforgiving and easily cause the modeler to become overwhelmed. The foundation for creating an effective 3-way financial model is understanding the organization, collecting the necessary data, and optimizing the model with accuracy and precision. These components will shape the model to fit the demands of the organization.
The process of building a 3-way financial model should be tailored to the organization’s size and complexity. To develop an effective 3-way financial model, the modeler must consider the organization's current level of operations and design a model that can grow and adjust as the organization grows and changes. Understanding the organizational hierarchy, the current level of operations, and the desired future level of operations will ensure the model is built with the appropriate features and functionalities.
In order to build an accurate 3-way financial model, the modeler must solidify a reliable data source from the organization. It is recommended to use multiple sources of data to ensure accuracy and precision. A comprehensive list of data must be created and taken into account for the purposes of creating all aspects of the 3-way model. A well-organized list of financial data should include, but not be limited to, historical trends, past performance of the organization, cost and revenue data, assumptions and forecasts.
Once the foundation of the 3-way model is built, the modeler can work to optimize the model, ensuring the organization’s needs are met. There are a variety of ways to optimize a 3-way financial model. Supporting assumptions must be taken into account for certain variables. Scenario analysis helps provide insights into the impact different assumptions can have on the end goal. In addition, macros can be created for certain tasks, allowing for more efficient usage.
- Understanding organizational hierarchy, current and future level of operations
- Collecting data from multiple sources
- Optimizing model with scenario analysis and macros
Keeping Your Model Up to Date
When choosing a three-way financial model, it is essential to keep it up to date. A three-way model is complex and relies on many different variables and assumptions. Keeping your model up to date is crucial for optimizing potential profit and mitigating potential losses. Here are a few tips for keeping your three-way model up to date.
Exploring Residual Values
The first step to keep your three-way model up to date is to explore residual values. Residual values are important because they give you an indication of the profitability of your investments. Keeping an eye on the residual values in your model can help you identify potential trends and opportunities in the market.
Identifying Variables that May Change
The next step to keep your model up to date is to identify variables that may change. Many things can change over the course of time, such as the price of commodities, currency exchange rates, and more. By keeping an eye on variables that may change, you can anticipate potential losses and take appropriate action.
Refining Your Model Regularly
The last step to keep your three-way model up to date is to refine it regularly. As time passes, new information will become available, and your model will need to be updated to stay relevant. Refining your model regularly can help you stay ahead of the curve and make sure your model stays up to date.
By exploring residual values, identifying potential variables that may change, and refining your model regularly, you can ensure that your three-way financial model remains up to date. Doing so can help you optimize potential profits and mitigate potential losses, making sure your investments pay off in the long run.
A 3 way financial model is an important tool used to represent a company’s overall financial performance. With the right model, your organization can gain an understanding of its financial health, find cost savings opportunities, identify areas of low or high performance, and make better-informed decisions. The proper selection and building of a 3 way financial model can yield significant financial rewards.
Summarizing Benefits of 3 Way Financial Model
Using a 3 way financial model helps to:
- Determine the success of financial decisions
- Evaluate current and potential investments
- Understand the inner workings of financials
- Determine the organization’s financial health
- Improve annual budgeting and forecasting
- Identify cost savings opportunities
Reminders for Accurately Selecting and Building Model
When selecting and building a 3 way financial model, remember to:
- Choose a model that meets the organization’s specific needs
- Organize and structure data correctly
- Ensure that variables are correct and valid
- Only use a data source that can be trusted
- Include sources of information that is up-to-date
- Test the model within the parameters of desired outcomes
- Include a back-testing regimen that is regularly applied
Encouraging Model Refinement
Once the 3 way financial model is created, it should not be considered a static tool. Regularly refine and adjust the model to reflect changes in financial data. As your business grows and evolves, be sure to adjust the models accordingly.