3-Statement Model (2024)

What is a 3-Statement Model?

The 3-Statement Model is an integrated model used to forecast the income statement, balance sheet, and cash flow statement of a company for purposes of projecting its forward-looking financial performance.

Table of Contents

  • How to Build a 3-Statement Model
  • How to Format the 3-Statement Financial Model
  • What is Periodicity in 3-Statement Modeling?
  • What is the Structure of a 3-Statement Model?
  • Basic Elements of an Integrated 3-Statement Model
  • SEC EDGAR: How to Gather Data for Financial Modeling?
  • How to Forecast the Income Statement
  • How to Forecast the Balance Sheet
  • How to Forecast the Cash Flow Statement (CFS)
  • How to Create Model Plugs? (Cash and Revolver)
  • How to Handle a Circularity in Excel?
  • How to Calculate Shares Outstanding and Earnings Per Share (EPS)
  • How to Perform Scenario Analysis in Excel
  • How to Conduct Sensitivity Analysis in Excel
  • What Skills are Required in Financial Modeling?
  • Why Does the 3-Statement Model Matter?

How to Build a 3-Statement Model

While accounting enables us to understand a company’s historical financial statements, forecasting those financial statements enables us to explore how a company will perform under various assumptions, and visualize how a company’s decisions interact to impact the bottom line in the future.

  • Operating Decisions → i.e. “Let’s reduce prices”
  • Investing Decisions → i.e. “Let’s buy an additional machine”.
  • Financing Decisions → i.e. “Let’s borrow a bit more”.

A well-built 3-statement financial model helps insiders (corporate development professionals, FP&A professionals) and outsiders (institutional investors, sell side equity research, investment bankers and private equity) see how the various activities of a firm work together, making it easier to see how decisions impact the overall performance of a business.

How to Format the 3-Statement Financial Model

It is critical that a complex financial model like the 3-statement model adheres to consistent best practices. This makes both the task of modeling and auditing other people’s models far more transparent and useful.

We have written an Ultimate Guide to Financial Modeling Best Practices, but we’ll summarize some key takeaways here.

The most basic formatting rules are:

Color-code your model so that inputs are blue and formulas are black. The table below shows other color-coding best practices:

Type of cellsColor
Hard-coded numbers (inputs)Blue
Formulas (calculations)Black
Links to other worksheetsGreen
Links to other filesRed
Links to data providers (i.e. CIQ, FactSet)Dark Red

Format data consistently (for example, keep consistent unit scale, use 1 decimal place for numbers, 2 for per share data, 3 for share count).

Avoid partial inputs that commingle cell references with hard numbers.

Maintain standard column widths and consistent header labels.

What is Periodicity in 3-Statement Modeling?

One of the first decisions in building a 3-statement financial model concerns the periodicity of the model.

Namely, what are the shortest periods the model will be partitioned into annual, quarterly, monthly, or weekly?

This will typically be determined by the purpose of the 3-statement financial model.

Below we’ve outlined some general rules of thumb:

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  • Annual Models →Common when using the model to drive a DCF model valuation. This is because a DCF model needs at least 5 years of explicit forecasts before making terminal value. LBO models are often also annual models, as the investment horizon is around 5 years. An interesting wrinkle with annual models is the handling of the “stub period,” which captures the latest 3-, 6-, or 9-months of historical data).
  • Quarterly Financial Models →Common in equity research, credit, financial planning and analysis, mergers and acquisitions (accretion/dilution) models where near-term issues are a catalyst. These models often roll up into an annual buildup.
  • Monthly Financial Models →Common in restructurings and project finance where month-to-month liquidity tracking is critical. One thing to note is that the data required for a monthly buildup is usually unavailable to outside investors unless it is privately provided by management (companies typically don’t report monthly data). These models often roll up into a quarterly buildup.
  • Weekly Financial Models →Common in bankruptcies. The most common weekly model is called the thirteen-week cash flow model (TWCF). The TWCF is a required submission in a bankruptcy process to track cash and liquidity.

What is the Structure of a 3-Statement Model?

When models get large, adhering to a strict structure is critical.

The key rules of thumb to follow include the following:

  • Use roll-forward schedules when forecasting balance sheet items.
  • Aggregate inputs in one worksheet or one section of the model and separate them from calculations and outputs.
  • Avoid linking files together.

Basic Elements of an Integrated 3-Statement Model

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An integrated 3-statement model

3-statement models include a variety of schedules and outputs, but the core elements of a 3-statement model are, as you may have guessed, the income statement, balance sheet, and cash flow statement.

A key feature of an effective model is that it is “integrated,” which simply means that the 3-statement models are modeled in a way that accurately captures the relationship and linkages between the various line items across the financial statements.

An integrated model is powerful because it enables the user to change an assumption in one part of the model to see how it impacts all other parts of the model consistently and accurately.

SEC EDGAR: How to Gather Data for Financial Modeling?

Before firing up Excel to begin building the model, analysts need to gather the relevant reports and disclosures.

At a minimum, they will need to gather the company’s latest SEC filings, press releases and possibly equity research reports.

Data is much harder to find for private companies than for public companies, and reporting requirements vary across countries. We have compiled a guide on gathering historical data needed for financial modeling here.

How to Forecast the Income Statement

The income statement illustrates a company’s profitability. All three statements are presented from left to right, with at least 3 years of historical results present to provide historical rations and growth rates on which forecasts are based.

Inputting the historical income statement data is the first step in building a 3-statement financial model.

The process involves either manual data entry from the given company’s 10K or press release or the use of an Excel plugin such as FactSet or Capital IQ to drop historical data directly into Excel.

Forecasting typically begins with a revenue forecast followed by the forecasting of various expenses. The net result is a forecast of the company’s income and earnings per share. The income statement covers a specified period such as a quarter or year.

For more on this, check out the complete income statement forecasting guide.

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Income Statement Screenshot from the Wall Street Prep Premium Package Training Program

How to Forecast the Balance Sheet

Unlike the income statement, which shows operating results over a period of time (a year or a quarter), the balance sheet is a snapshot of the company at the end of the reporting period. The balance sheet shows the company’s resources (assets) and funding for those resources (liabilities and shareholder’s equity). Inputting historical balance sheet data is similar to inputting data in the income statement. The data is inputted either manually or through an Excel plugin.

In large part, the balance sheet is driven by the operating assumptions we make on the income statement. Revenues drive the operating assumptions in the income statement, and this continues to hold true in the balance sheet: Revenue and operating forecasts drive working capital items, capital expenditures, and a variety of other items. Think of the income statement as the horse and the balance sheet as the carriage. The income statement assumptions are driving the balance sheet forecasts.

Click here for a complete guide to forecasting the balance sheet

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Balance Sheet Screenshot from the Wall Street Prep Premium Package Training Program

How to Forecast the Cash Flow Statement (CFS)

The final core element of the 3-statement model is the cash flow statement. Unlike on the income statement or the balance sheet, you aren’t actually forecasting anything explicitly on the cash flow statement and it isn’t necessary to input historical cash flow statement results before forecasting. That’s because the cash flow statement is a pure reconciliation of the year-over-year changes in the balance sheet.

Every individual line item on the cash flow statement should be referenced from elsewhere in the model (it should not be hardcoded) as it is a reconciliation. Constructing the cash flow statement correctly is critical to getting the balance sheet to balance.

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Cash Flow Statement Screenshot from the Wall Street Prep Premium Package Training Program

How to Create Model Plugs? (Cash and Revolver)

A universal feature of a 3-statement model is that cash and a revolving credit line serve as model “plugs.” This simply means that a 3-statement model has an automatic way of ensuring that when the model projects a cash shortfall after all the line items are forecast, additional debt via a “revolver” account will automatically increase to finance the shortfall. Conversely, if the model projects a cash surplus, cash will accumulate by the amount of the surplus. While this seems fairly logical, modeling this can be tricky. Click here for a guide to forecasting the revolver and cash balance with a free excel template

How to Handle a Circularity in Excel?

Many financial models have to deal with a problem in Excel called circularity. A circularity in Excel occurs when one calculation either directly or indirectly depends on itself to arrive at an output. In the 3-statement model, a circularity can occur because of the model plugs described above. This makes Excel unstable and can create a variety of problems for those using the model. There are several elegant ways to deal with this issue. To learn more about how to deal with circularity, go to the “Circularity” section of our guide on financial modeling best practices.

For public companies, projecting earnings per share is key. Forecasting the numerator of EPS is described in detail in our income statement forecasting guide, but forecasting shares outstanding can be done in a variety of ways, ranging from simply keeping the historical share count constant to a more sophisticated analysis that takes into account forecasts for share repurchases and issuances. Click here for a guide to forecasting EPS.

How to Perform Scenario Analysis in Excel

The purpose of building a 3-statement financial model is to observe how various operating, financing and investing assumptions impact a company’s forecasts. Once the initial case is built, it is useful to see — using either equity research, management guidance, or other assumptions — how the forecasts change given changes in a variety of key model assumptions. To this end, financial models often have a drop-down list that provides the user with the option to select either the original case (often called “base case”) or a variety of other scenarios (“strong case,” “weak case,” “management case,” etc.), which is referred to as scenario analysis.

How to Conduct Sensitivity Analysis in Excel

A close cousin of scenario analysis is sensitivity analysis. Any good 3-statement financial model (or a DCF model, LBO model, or M&A model, for that matter) will include the ability to toggle between various scenarios to see how the model’s outputs change, as well as something called sensitivity analysis. Sensitivity analysis is the process of isolating one (usually critical) model output to see how changes impact one or two key inputs.

For example, how would Apple’s 2020 EPS forecast change at various assumptions for 2020 revenue growth and gross profit margins? Click here to learn how to build a sensitivity analysis into a 3-statement model.

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What Skills are Required in Financial Modeling?

Building a 3-statement financial model requires the combination of the following skills:

  • Excel: Getting strong in Excel may seem daunting, but it’s actually the easiest skill on this list to develop. A general rule of thumb in finance is to avoid using the mouse and memorize some keyboard shortcuts. Accounting: This is the single most important (and least glamorous) part of getting strong in modeling. Understanding how the three financial statements are tied together and what each line item on the income statement, balance sheet and cash flow statement represents is the key to the conceptual understanding of how a 3-statement financial model works.
  • Reading Financial Reports: Even though 3-statement financial models are designed to illuminate a firm’s future performance, setting up the model depends on a thorough understanding of what happened to the company in the past. For that, investment bankers and investors gather historical financial data. Whether you’re looking through SEC filings or quarterly press releases, or modeling a private company where you’re only provided piecemeal disclosures, finding the data you need will feel like a scavenger hunt. Your ability to navigate those reports and to find the exact data you are seeking can make a difference when building a model.
  • Company and industry knowledge: One of the realities for new investment bankers is that they are often tasked with building a lot of models for industries and companies they don’t really know and don’t have time to learn. A 3-statement financial model’s assumptions about things like revenue growth and profit margins are critical to making a good forecast, so knowing the resources available to collect company and industry insights is very important. Quite often, investment bankers rely on sell side equity research to quickly get smart on the company and industry. Meanwhile, institutional investors (who, unlike investment bankers, have skin in the game) spend even more time getting to know the company, often through a lot of due diligence such as speaking with management and customers, going on-site visits, and trying out products themselves.
  • Attention to detail: One wrong decimal place is all it takes to completely screw up a model. In investment banking, corporate finance, and equity research, the stakes are high and attention to detail is often the difference between getting promoted and getting fired.

Why Does the 3-Statement Model Matter?

At their core, all M&A, DCF, and LBO models depend on forecasts produced in the 3-statement model.

The output of a 3-statement model serves as the foundation for several types of financial models:

  • Discounted Cash Flow (DCF) Modeling: In investment banking, private equity, and on the investment management side, practitioners value companies using a methodology called the DCF approach. This approach looks at a company’s future expected cash flows and discounts those cash flows to the present. While analysts sometimes rely on a “back of the envelope” approach when building the DCF, a rigorous DCF analysis requires a full 3-statement model to feed the cash flow forecasts.
  • Mergers & Acquisitions (M&A) Modeling: To analyze the impact of an acquisition on a variety of key considerations for buyers and sellers, such as the acquirer’s profitability, accretion/dilution, capital structure, synergies post-acquisition, and the seller’s tax implications, 3-statement financial models for both companies need to be constructed and fused together.
  • Leveraged Buyout (LBO) Modeling
    The only way to truly understand how a leveraged buyout (or a management buyout) or a corporate bankruptcy or restructuring will impact a company’s performance (and thus ultimately determine the potential returns to the financial sponsors and lenders involved in the buyout), is to construct a 3-statement financial model for the buyout candidate, and it must be flexible enough to handle the new leveraged capital structure.

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Surekha

September 17, 2019 1:10 pm

Wonderful. I have a question. I have seen 3 statement model which is generated with the help of VBA bases macros. I guessed it needs some support files like simulation, forecasting assumptions etc to build a model. How to prepare these support files? Is it really required for modeling? ApartRead more »

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Jeff Schmidt

September 21, 2019 5:20 pm

Reply toSurekha

Surekha: Yes, you would need to populate some files with forecasts to pull into your VBA-based workbook. Unfortunately, there’s no way for me to tell what you need to forecast and in what format the files should be created. This would be based on the macros in your file. Best,Read more »

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Wilson Izekor

August 22, 2022 4:21 am

Please how do i include inflation rate in the financial model. How do I link them to the numbers in the model?

Reply

Brad Barlow

August 24, 2022 10:50 pm

Reply toWilson Izekor

Hi, Wilson,

Financial models are usually projected in nominal terms, so not controlling for the loss of purchasing power through monetary inflation. You would capture inflation through projecting rising costs and (hopefully) rising prices in the sale of goods.

BB

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3-Statement Model (2024)

FAQs

How long should a 3-statement model take? ›

The “strict time limit” could be anything from 30 minutes to 3-4 hours, and the complexity increases as the time limit increases. The “no strict time limit” type might give you several days or even 1 week+. There is still a deadline, but you don't need to rush around like a madman to finish.

What is the 3-statement model assessment? ›

What is a 3-Statement Model? The 3-Statement Model is an integrated model used to forecast the income statement, balance sheet, and cash flow statement of a company for purposes of projecting its forward-looking financial performance.

What are the advantages of the 3-statement model? ›

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.

What is the difference between DCF and 3-statement model? ›

In a DCF model, similar to the 3-statement models above, you start by projecting the company's revenue, expenses, and cash flow line items. Unlike 3-statement models, however, you do not need the full Income Statement, Balance Sheet, or Cash Flow Statement.

How long does it take to get good at financial modeling? ›

The time it takes to learn financial modelling varies based on individual factors. Prior knowledge, learning resources, practice, and the complexity of the models all matter. While some might grasp the basics in a matter of weeks, mastering financial modelling can take several months to a year or more.

Which is the best method for calculating interest expense? ›

The simplest way to calculate interest expense is to multiply a company's total debt by the average interest rate on its debts. If a company has $100 million in debt with an average interest rate of 5%, then its interest expense is $100 million multiplied by 0.05, or $5 million.

What is the 3 way budget model? ›

What is a 3-way budget? A 3-way budget is a strategic financial plan that aligns three essential financial statements: the P&L, the Balance Sheet, and the Cash Flow Statement. It is typically set once a year.

What is the advanced 3 statement model? ›

A three-statement financial model is an integrated model that forecasts an organization's income statements, balance sheets and cash flow statements. The three core elements (income statements, balance sheets and cash flow statements) require that you gather data ahead of performing any financial modeling.

What are the advantages and disadvantages of using a model? ›

The advantage of using a model is that it allows prediction and simplification of complex systems. On the other hand, the disadvantage of a model is that they could be misleading and can be misinterpreted in a different way.

What is the 3 statement model in real estate? ›

Unlike corporations, which use three statement modeling (income statement, balance sheet, and cash flow statement), a real estate model is primarily a cash flow statement with several ancillary pages on the revenues, costs, financing, metrics, and returns.

How to build a DCF from a three statement model? ›

Steps to Building a 3-Statement Financial Model:
  1. Gather Historical Data and From Future Assumptions.
  2. Forecast the Income Statement.
  3. Create Supporting Schedules such as Fixed Assets and Debt.
  4. Forecast the Balance Sheet.
  5. Forecast the Cash Flow Statement.
Jul 31, 2020

What are two weaknesses of the DCF model? ›

The main Cons of a DCF model are:

Very sensitive to changes in assumptions. A high level of detail may result in overconfidence. Looks at company valuation in isolation. Doesn't look at relative valuations of competitors.

Is DCF Modelling hard? ›

No, DCF (Discounted Cash Flow) analysis is not necessarily the hardest analysis in finance. It is a widely used method to determine the value of an investment based on its expected future cash flows, but its accuracy and usefulness depends on the quality and reliability of the inputs and assumptions used.

How long does a DCF model take? ›

The first step in the DCF model process is to build a forecast of the three financial statements based on assumptions about how the business will perform in the future. On average, this forecast typically goes out about five years. Of course, there are exceptions, and it may be longer or shorter than this.

How long does the Wall Street Prep financial modeling course take? ›

Course Highlights

You should expect to spend approximately 20-30 hours to complete it. The program uses online video lessons, Excel model templates and various financial filings to teach students how to build, analyze, and interpret financial models in a step-by-step fashion at their own pace.

What is the 3 way forecast model? ›

A three-way forecast, also known as the 3 financial statements is a financial model combining three key reports into one consolidated forecast. It links your Profit & Loss (income statement), balance sheet and cashflow projections together so you can forecast your future cash position and financial health.

How does interest expense flow through the three statements? ›

Financing events such as issuing debt affect all three statements in the following way: the interest expense appears on the income statement, the principal amount of debt owed sits on the balance sheet, and the change in the principal amount owed is reflected on the cash from financing section of the cash flow ...

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