A 3 Way Financial Model is a type of financial model that facilitates a comprehensive overview of a company's financial performance. It is designed to provide stakeholders with a comprehensive analysis of current financial performance and help them accurately project future results. It is based on three core financial statements: The Balance Sheet, the Income Statement, and the Cash Flow Statement.
The Benefits of a 3 Way Financial Model are manifold:
- It provides an overview of a company's performance, enabling stakeholders to make informed decisions.
- It provides an approximation of future financial performance so stakeholders can better plan for the future.
- It assists in the forecasting of future performance, allowing for improved strategic planning.
- It allows stakeholders to monitor the progress of financial performance over time, enabling them to identify potential issues or opportunities.
- A 3 Way Financial Model provides an overview of a company's performance.
- It enables stakeholders to make accurate future projections.
- It assists in the forecasting of future performance for improved strategic planning.
- Experienced stakeholders can monitor progress over time to identify potential issues or opportunities.
Exploring What a 3 Way Financial Model Consists Of
Before getting into the process of creating an effective 3 way financial model, it is important to understand what exactly such a financial model is, and what it consists of. A 3 way financial model consists of three key financial statements – income statement, balance sheet, and cash flow statement.
An income statement, also known as a Profit & Loss statement, is a financial statement that outlines the revenues, expenses, and profits for a specified period of time. This statement is used to help analyze the profitability of a business or organization. The income statement typically shows how total income is broken down into expenses, operating income, and net income to give an overall picture of a company’s performance.
A balance sheet is a financial statement that captures the financial position of a business or organization at a specified date. A balance sheet contains all the assets, liabilities, and equity of the business. This statement is used to understand the financial strength of the business, and whether the business has the ability to meet its obligations.
Cash Flow Statement
A cash flow statement is a financial statement that shows the sources and uses of a company’s cash over a specified period of time. This statement captures the cash inflows and outflows of the business, and helps to identify the sources of cash that are creating the most value for the business. The cash flow statement is an important tool in understanding the financial health of a business or organization.
By understanding the components of a 3 way financial model, it is possible to see how the different statements come together to give a clear picture of the financial performance of a company. Armed with this knowledge, you can begin to create an effective 3 way financial model to assess and monitor the performance of a business.
Assumptions for the Model
Before creating an effective three-way financial model, it is important to make important assumptions regarding future revenues, profits, costs, and expenses. These assumptions should be based on current performance trends and industry research. Financial assumptions may include pricing and sales volume estimates, sales margins, expected operating expenses, and capital expenditure assumptions. It is also important to consider risks associated with each assumption and to make realistic assumptions that will be achievable over the model's timeline.
Economic assumptions are important to consider when creating a three-way financial model, as they have a direct impact on the performance of a business. Assumptions may include expected inflation rates, taxation laws, and levels of economic activity. It is also wise to consider trends in interest rates, capital flows, and other macroeconomic forces when making assumptions about the future performance of a business.
Industry assumptions are also important when creating a three-way financial model. These assumptions may involve trends in customer demand, industry-wide pricing, technological changes, and regulatory changes. It is also important to consider areas of potential growth and disruption, as well as competitive forces that may influence the performance of a business. It is wise to stay up-to-date on changes in the industry and to incorporate these into the assumptions made in the model.
How to Gather Reliable inputs
Building a three-way financial model requires collecting pertinent information to populate the model. To ensure the model is an accurate representation, it is important to obtain reliable inputs. There are two primary sources for collecting inputs: external sources and internal sources.
Utilize External Sources
External sources are often more reliable when constructing a financial model. These sources can include financial filings from the SEC, government databases, media resources, and other reliable outlets. Because external sources are not subject to bias or opinion, they are generally more accurate for trustworthiness and accuracy.
Accessing external databases can provide industry-wide averages and benchmarks for comparison, or an overview of the industry you are analyzing. For example, Global Data’s Market Intelligence platform provides insights into industry-specific financial data collected from reliable sources.
Incorporate Internal Sources
Aside from external sources, internal sources such as IT systems and processes can provide reliable inputs. This includes sales histories, cost structures, customer contracts, or production processes. Internal sources can provide an in-depth view of a company or industry, as they are specific to that company or industry.
Many financial modelling tools, including Microsoft Excel and Power BI, have capabilities to connect to enterprise systems for directly pulling data into the model. This automation can save time, improve accuracy of the financial model and ensure that the data used is the most up-to-date and reliable.
Types and Uses of a 3 Way Financial Model
A three-way financial model is an analytical tool used to assess an investment's possible performance and to project future outcomes. It provides a visual representation of three financial components—cash flows, expenses, and income—over a defined period of time. This type of model is popular in businesses, financial institutions, and real estate sectors for decision-making purposes.
Predict Investment Performance
The main purpose of a 3 way financial model is to act as a predictive tool for investors. It provides an opportunity to project cash flows and returns of a particular investment. This helps investors make decisions about prospective investments by seeing how their funds may be affected in the future based on the estimated outcomes. It also helps identify potential risks and determine the most appropriate course of action to take.
Analyze and Forecast Future Events
In addition to predicting future performance, a three-way financial model can also be used to analyze and forecast future events. By using assumptions, trend lines, and data points, the model can help anticipate potential changes to the company’s financial situation. This allows investors to make adjustments to their plans and mitigate potential risks.
The three way financial model is a powerful tool that can be used to help make informed decisions about investments by predicting performance and forecasting future events. Having a comprehensive model allows for more accurate decisions, helping investors to make the most of their investments.
Significant Features to Include
Creating an effective three-way financial model involves more than just the right variables and formulas. Once the data points and calculations are in place, certain features need to be included to make the model robust and accurate. Below are some of the more common features to include in a three-way financial model.
The core of the model is the data points. These can include past figures and performance as well as estimates for the upcoming year. The data should be including actual data from past periods worked into trends and analyzed for comparable ratios. The value of the model will depend on the accuracy and precision of the data points included.
The calculations should include financial ratios and the correlations between the data points. The model should also factor in assumptions and other variables that affect the financial plans of the company. The formula should have code that allows for easy adjustments and testing of different scenarios. This helps management understand how the company can respond when conditions change.
A 3 way financial model is an important financial tool that can be used to outline and analyze the estimated future financial performance of a business or other entity. Utilizing this type of forecasting model can provide businesses with a shift in focus from past performance and provide an understanding of potential future performance.
Creating an effective 3 way financial model requires a deep understanding of the business’s current financial status, the target performance goals, the business’s strategy, and the assumptions believed to be driving the business’s projected financial performance. The model should be constructed to encompass and accurately represent all of these components, and should be detailed, flexible and scalable.
Recap of the Importance of a 3 Way Financial Model
A 3 way financial model serves as a powerful tool which can help businesses visualize the performance of all of the components which add to, detract from or contribute to their financial position in the future. It can provide deep insight into the business’s current and future health, as well as the likely outcome of different strategies, investments, and financing options.
Overview of the Necessary Steps to Create an Effective 3 Way Financial Model
- Recognize the goals of the 3 way financial model.
- Understand the elements of the 3 way financial model.
- Research the historical financials of the business.
- Perform a SWOT analysis.
- Build the projection model.
- Establish assumptions.
- Analyze the financial projections.
Constructing an effective 3 way financial model is a complex task and requires a deep understanding of the business’s financials and its target performance goals. Following the necessary steps should ensure a robust and accurate 3 way financial model is created.