Introduction

Making accurate financial investment predictions is a complex task. Fortunately, there is a dependable tool -- the three-way financial model -- that can make the job simpler and more accurate. In this blog post, we'll discuss the components of a 3-way financial model and provide step-by-step guidance on how to use and interpret the information it offers.


Key Takeaways

  • Components of a 3-way financial model
  • How to use and interpret the information it offers
  • Step-by-step guidance to help you get started

Three Financial Statements

A 3-way financial model can be used to make accurate predictions through the use of three different financial statements: the balance sheet, the profit and loss statement and the cash flow statement. Each of these statements provides valuable insight and helps to ensure that financial decisions are based on facts.

Balance Sheet Statement

The balance sheet statement is an overall financial picture of the company. It includes information such as the company’s assets, liabilities, and equity. This statement is used to calculate how well the company’s financials are performing.

Profit and Loss Statement

The profit and loss statement shows the company’s income and expenses over a period of time. This statement helps evaluate the performance of the business and determines whether the company is making a profit or suffering a loss.

Cash Flow Statement

The cash flow statement is a representation of the cash coming in and going out of a company. This statement tracks the cash inflows and outflows of the business, and helps determine how the company’s cash transactions are affecting the overall financial health.


The Benefits of Using a 3 Way Financial Model

Having an accurate and properly constructed financial model is essential for many businesses, including startups and established companies. By using a 3 way financial model, businesses are able to make accurate predictions and plan strategically for the future. Here are 3 key benefits of using a 3 way financial model.

Easier to analyze numbers

A 3 way financial model offers a much more detailed and accurate look at a company’s financials than a one-way or two-way model. By analyzing the three ways a business creates cash flow — profits and expenses, capital, and debt — companies are able to more accurately project their current and future cash flows. This allows managers to make better decisions about capital investments, financing strategies, and other financial matters.

More Comprehensive

The 3 way financial model is a comprehensive and powerful tool that businesses can use to plan for their future. A 3 way financial model includes both “bottom-up” and “top-down” modeling, allowing companies to analyze their finances from both an operational and a strategic level. The comprehensive picture that a 3 way model provides helps managers to make better decisions and more accurately predict the company’s future.

Helps identify and mitigate risks

By using a 3 way financial model, companies are better able to identify risks and develop strategies to mitigate them. The detailed view of a company’s finances that a 3 way model provides helps managers to identify risks and vulnerabilities, develop strategies to reduce their risk profile, and plan for their future success.

Using a 3 way financial model is an effective way for businesses to make more accurate predictions about their finances. A 3 way model offers a more comprehensive view of a company’s finances and helps managers to identify and mitigate risks. For these reasons, it is an essential tool for any business that wants to make accurate predictions and plan strategically for the future.


4 Steps to Applying the 3 Way Model

Create and Enter Assumptions

The 3-way financial model is an incredibly powerful tool to help businesses and entrepreneurs accurately predict the costs and benefits of any entity or process. Before applying the model, it’s important to create and enter assumptions into the model to ensure that the model takes into account the expected behavior of the entity or process. These assumptions should include items such as expected costs, expected revenue or benefit, estimates of items such as unit costs, expected price points, etc. Ensuring that these assumptions are as accurate as possible is key for achieving the best results from the model.

Analyze Balance Sheet Statement

Once the assumptions have been entered, the next step is to analyze the Balance Sheet Statement provided by the model. This statement will provide a snapshot overview of the entity's assets and liabilities, which is essential for determining the future success of the entity. Analyzing this statement reveals any existing potential problems that may need to be resolved, such as if the entity has more liabilities than assets, or any other issues that can provide clues as to where to focus efforts.

Analyze Profit and Loss Statement

Another important step in the process is to analyze the Profit and Loss Statement provided by the financial model. This will provide valuable insight into the current and potential future performance of the entity, making it easier to identify areas of potential improvement or risk. Analyzing this statement can provide useful data such as the number of sales, profits or losses, expenses, and the like. With this data, it’s possible to determine how to best adjust or optimize different aspects of the entity’s operations.

Analyze Cash Flow Statement

The Cash Flow Statement provided by the 3-way financial model is the final step in the process. This statement provides an overview of the inflows and outflows of cash that the entity experiences. This is an essential statement to analyze, as it can provide invaluable information to pinpoint the areas where a company can improve its operations. By analyzing this statement, it’s possible to identify any potential problems related to cash flow and determine potential solutions for those issues.


5 Considerations for Your Model

Your 3 way financial model will be an indispensable tool to accurately predict revenue and expenses. When constructing your model, the following considerations should be taken into account.

Type of company

Considering the type of company you are developing the model for is essential. Whether it be a publicly-traded enterprise or a private family business, the model has to fit the specific circumstances, such as capital ownership, liability, and debt structure. This will enable you to formulate assumptions regarding the most likely capital structure.

Industry

The industry your model applies to will have a considerable impact on the assumptions you make when you are assembling the model. From the cyclicality of public companies to the cash flow patterns of small businesses, everyone’s model will look different for the same type of industry.

Fiscal tax year

The fiscal tax year is essential in determining the time frames where assumptions are made, including any fluctuation in tax rates that could affect your model. The start and end of the tax year can also affect any seasonal patterns that you may include in the model.

Accounting Calculations

The accounting calculations you use when creating and using a 3-way financial model will be determined by the assumptions and context of your model. It is important to understand how specific criteria of your model impacts the accounting and how your calculations are being applied.

Model Testing

Finally, it is important to understand the range of tests that have to be applied to your model in order to validate that the projections you are making are accurate. This might include short-term and long-term budget forecasting, deploying a comprehensive sensitivity analysis, and replicating previous performance levels.


6 Resources for Building Financial Models

Financial models can be incredibly useful for making accurate predictions. Whether you are trying to predict baseline revenues for a new business venture, or determining the profitability of an existing project, a 3 way financial model can provide insights for making the most effective decisions for your organization.

Example models

Good starting point for creating a 3 way financial model is to review existing examples. There are a number of publically available resources, such as the CFO Daily 3 Way Financial Model Examples, that provide templates and examples you can use as a model to build your own.

Live help resources

In some cases, it is helpful to have someone walk you through the modeling process. There are a number of live help resources available, such as CFO Live 3 Way Financial Model Help, where you can consulted with professionals in the field.

Tutorials

Another great option is to learn the process through tutorials. There are a number of tutorials available, such as the CFO Daily 3 Way Financial Model Tutorial, that you can use to learn to develop your own 3 way financial models.


Conclusion

When it comes to predicting and forecasting financial performance, a 3-way financial model can provide more detailed and accurate insights than simpler approaches. This article has outlined the steps for applying a 3-way model and highlighted some of the key benefits. The following resources can help you learn more about the process and develop your model-building skills.

Summarize Benefits of 3-Way Model

A 3-way financial model combines the Income Statement, Balance Sheet, and Cash Flow Statement into a single interactive report. This enables the user to explore the relationships between financial statements, spot early warning signs of financial difficulty, and explore opportunities for growth. By incorporating essential forecasting and decision-making assumptions, it provides powerful insights for strategic decision-making.

Overview of Important Steps for Applying a Model

The following steps are fundamental to constructing and applying a 3-way financial model:

  • Develop the framework of the model.
  • Create the links between financial statements.
  • Input and project key financial variables.
  • Analyze trends, variances, and correlations.
  • Calculate key financial ratios.
  • Determine the best course of action.

Resources for Learning More about the Process

If you're looking to refine your financial modeling skills, there are a number of resources available online. Here are some recommended websites for further information:

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