Introduction

A three way financial model is a type of financial analysis used to provide a comprehensive and analytical overview of a business's performance. The model is built on three essential moving parts - income statement, balance sheet and cash flow statement. By combining these documents and analyzing their relationship within a set of predetermined parameters, a business is able to gain an in-depth view of its financial standing.

Understanding the pros and cons of implementing a 3 way financial model is essential for any business. Moreover, it is beneficial in deciding if a 3 way financial model would be an ideal approach to analyze a business's performance.

Overview of Pros and Cons

  • Pros
    • Comprehensive and detailed analysis of a business's performance
    • Cost effective approach to evaluating a business's financial standing
    • Provides the necessary insights and evidence to take the right decisions
  • Cons
    • Difficult to track changes in a dynamic environment
    • Time consuming to maintain a three way financial model
    • Requires expertise in financial analysis

Key Takeaways:
  • Comprehensive and detailed analysis of a business's performance
  • Cost-effective approach to evaluating a business's financial standing
  • Requires expertise in financial analysis
  • Time consuming to maintain a three way financial model
  • Difficult to track changes in a dynamic environment

Pros of Establishing a 3 Way Financial Model

One of the most obvious advantages of implementing a 3 Way Financial Model is improved financial projections. In the traditional two-way model, the balance sheet and cash flow statement are considered separately. With a 3 Way Financial Model, additional insights can be derived by considering these statements together. For example, cash flow is supplemented and refined by including the effects of balance sheet transactions, such as inventory losses or accounts receivable.

Easier asset allocation is another positive of using a 3 Way Model. Since the 3 Way Financial Model considers more components of the financial statements, it is easier to estimate the asset types, such as stocks and bond investments, needed to optimize return on investments over a certain timeframe. Furthermore, by looking at all three components of the financial statement, it is easier to make an accurate assessment of a company's existing capital situation and adjust their asset management strategy in order to maximize capital return.

Finally, with a 3 Way Financial Model there is greater efficiency in resource planning. By looking at the financial statement in a comprehensive manner, one can take into account the impact of all operations on the financial health of the business. This allows managers to identify which areas are overusing resources, which are underusing resources, and areas where resources could be reallocated in order to reduce costs or create more value for the business.


3. Cons of Establishing a 3 Way Financial Model

The drawbacks and risks of implementing a 3 way financial model should be considered carefully before adoption. Some of the primary drawbacks when businesses opt to use a 3 way financial model include decreased ability to react to changing market conditions, difficulty estimating unknown future variables, and risk of unforeseen financial consequences.

A. Decreased Ability to React to Changing Market Conditions

The 3 way financial model requires a degree of financial planning that may challenge a business’s ability to react to changing external factors. Most long-term financial models anticipate only fixed or predictable trends and their decisions are based on the data collected. If external conditions change significantly, it may be hard to effectively adjust the 3 way financial model to accommodate them. This can lead to costly errors and inaccuracies.

B. Difficulty Estimating Unknown Future Variables

The 3 way financial model relies heavily on clearly defined financial projections that may not always be accurate. Estimating unknown variables such as future expenses and revenues can be especially difficult which can lead to inaccurate forecasts. Additionally, many businesses have difficulty predicting market trends that have a major impact on their 3 way financial model.

C. Risk of Unforeseen Financial Consequences

Finally, the 3 way financial model often requires businesses to take risks in order to make the desired gains. These risks, while calculated, often come with the risk of unforeseen or difficult-to-predict financial consequences. Businesses must account for these risks in their 3 way financial model in order to minimize their losses in the event of an unexpected result.


Comparing Pros and Cons

When considering the advantages and disadvantages of implementing a 3 Way Financial Model, it is important to keep in mind the needs and goals of the organization, as well as the level of complexity designed into the model. This can help guide decision makers to determine the best approach for their organization.

Consideration of Needs and Goals

The first step when evaluating the benefits and drawbacks of implementing a 3 Way Financial Model is to consider the needs and goals of the organization. Without fully understanding the overall objectives, attempting to choose a model that meets the organization's needs can seem quite daunting. A thorough assessment of the organization's current and short-term goals should be made prior to making any decisions regarding the model.

After understanding the goals and needs, decision makers can then use various analytical tools and techniques to determine if the 3 Way Financial Model is the best fit for the organization. By conducting a cost/benefit analysis, information can then be gathered and analyzed to determine whether the 3 Way Model is the best solution for the organization or if an alternate model should be considered.

Determining the Level of Complexity Required

It is also important to consider the complexity of the 3 Way Financial Model when deciding whether or not to implement it. Different models can vary significantly in their levels of complexity, and organization leadership must determine the degree of complexity necessary to meet the needs and goals of the organization. Based on this information, decision makers can then decide if the 3 Way Model is the best fit for the organization.

The size and scope of the organization can also be a factor in determining the complexity of the 3 Way Model. For example, larger organizations that have multiple departments may require a more extensive and complex model in order to accurately manage their finances. It is important to consider the size and scope of the organization when deciding if a 3 Way Model is the best fit.


Reasons for Implementing a 3 Way Financial Model

A 3 way financial model is an effective tool for analyzing the long-term goals and requirements of a business. This type of model is based on three key components - profits, cash flow, and balance sheet structure - which are designed to provide an in-depth evaluation of a company's operations. While implementing a 3-way financial model is not a one-size-fits-all solution for every organization, there are several distinct benefits associated with this approach.

Improved Goal Setting

One of the key benefits of a 3-way financial model is improved goal setting. By looking at future cash flows, balance sheet items, and profits, businesses can more accurately understand what they need to do in order to achieve their desired objectives. Additionally, through incorporating financial projections into the model, businesses can develop achievable short and long-term goals and identify how to best achieve them.

Increased Financial Transparency

A 3-way financial model also provides increased financial transparency. As the model requires a detailed breakdown of all associated transactions, companies can more easily recognize potential risks and opportunities and plan accordingly. This helps provide greater clarity on the financial health of the organization, which can help business leaders make informed decisions and determine the best course of action.

Better Risk Management

Lastly, a 3 way financial model can effectively improve the risk management of a business. By generating a complete assessment of cash flows and balance sheet items, businesses are better equipped to identify and mitigate potential risks. This helps to create a robust system of risk management and better prepare companies for uncertain market conditions.

Overall, a 3-way financial model is a powerful tool that can improve goal setting, increase financial transparency, and better manage risk. By fully understanding the advantages and disadvantages of this approach, businesses can determine if a 3-way financial model is right for them.


Reasons for Not Implementing a 3 Way Financial Model

When attempting to decide whether or not to implement a three way financial model, it is important to consider both the potential benefits as well as any drawbacks that might be associated with such a system. This section examines several reasons why a three way financial model might not be the best choice for some organizations.

Risk of Unmet Expectations

When utilizing a three way financial model, it is important to consider the possibility that the model might not be able to produce the desired results. Despite being a powerful tool for risk management and financial planning, a three way model cannot guarantee success. For this reason, it is important that organizations considering implementing such a model recognize the potential for failure and be prepared for potential outcomes that differ significantly from those that were originally anticipated.

Additional Complexity

A three way financial model can quickly become complex due to the number of variables that must be taken into account. If an organization is not prepared to prioritize the necessary data and ensure accuracy at all times, the model may become increasingly difficult to manage. As such, organizations should thoroughly analyze their ability to keep track of all necessary variables and data points before implementing a three way financial model.

Vulnerability to External Variables

The efficiency of a three way financial model could be threatened by any changes or shifts in the external environment. Possible changes could include fluctuations in exchange rates, or macroeconomic shifts that affect the availability or cost of resources. As such, it is important that organizations be prepared to continuously assess their models to ensure that they are equipped to handle any such changes.


Conclusion

When considering a 3-way financial model, it is important to evaluate both the potential benefits and consequences of such a model. It is likely that the benefits will outweigh the potential consequences, and thus implementing a 3-way financial model is likely to act as an overall benefit to a business. With careful consideration and planning, this could result in a successful and efficient system.

Benefits of Implementing a 3 Way Financial Model

  • Accurate and timely reporting
  • Reduced financial planning and budgeting costs
  • Greater transparency and visibility into organizational finances
  • Enhanced collaboration between teams
  • More efficient forecasting and decision-making capabilities

Possible Consequences of Implementing a 3 Way Financial Model

  • Increased complexity
  • Additional upfront costs for setup and training
  • Possibility of disruption to existing operations
  • A need to continuously review and update data

Excel financial model

  • 5-Year Financial Projection
  • 40+ Charts & Metrics
  • DCF & Multiple Valuation
  • Free Email Support