FINANCIAL MODELLING
THREE STATEMENT MODEL
THREE STATEMENT MODEL
The three-statement model forms the bedrock of financial modelling. This
model is essential for analysing a company's financial performance and
projecting its future forecasting based on various key assumptions and
input variables.
The three-statement model is the comprehensive & core framework in
financial modelling that integrates a company’s three main financial
statements:
1. Income Statement (P&L Statement)
2. Balance Sheet
3. Cash Flow Statement
The purpose is to project a company’s financial performance and
position over a period, while ensuring all three statements are linked
and consistent.
It is the foundation for valuation models (DCF, LBO, M&A) and scenario
planning.
Purpose & Goals of the Three Statement Model
• Easy to understand as well should be relevant, dependable and
comparative.
• Integrated Forecasting: The model allows users to see how
changes in one statement affect the others, providing a dynamic
view of the company's financial situation through prediction.
For example, net income from the income statement impacts
retained earnings on the balance sheet and serves as the starting
point for the cash flow statement.
• Decision-Making: By using the model, analysts can evaluate the
potential impact of various business decisions, such as changes in
pricing, investment in new projects, or financing strategies.
THREE STATEMENT MODEL
• Valuation and Analysis: This model serves as the foundation for
more complex financial models, such as,
- Discounted Cash Flow (DCF) models,
- Leveraged Buyout (LBO) models, and
- Merger & Acquisition models.
It is widely used in investment analysis, budgeting, and corporate
finance activities.
THREE STATEMENT MODEL
Income Statement commonly known profit or loss statement. It depicts
company’s financial performance over a specific period. By answering,
“Did we make money or lose money in the business?” tracking
through,
✓ Revenue (money coming in)
✓ Expenses (money going out)
✓ Net Income (what’s left over)
A diary of your business in the terms of finance.
Key Components of the Income Statement
Section What It Means Analogy for fun
Total income from selling “I sold 100 samosas. I’m
Revenue (Sales)
goods/services rich in carbs and cash.”
Cost of Goods Sold – direct “Flour, oil, and auntie’s
COGS
costs of producing goods secret masala recipe.”
“Profit before rent and
Gross Profit Revenue minus COGS
emotional damage.”
Salaries, rent, marketing, “Paid ₹10,000 for ads.
Operating Expenses
admin cost etc. Got 3 likes. Worth it?”
Gross Profit minus Operating
Operating Income “Still surviving. Barely.”
Expenses
Other Interest, gains/losses from “Earned ₹500 interest. Lost
Income/Expense investments ₹600 in crypto.”
Interest, Taxes & Adjustments before arriving “Government wants a piece
Depreciation at net income. of my samosa empire.”
Final profit or loss after all
Net Income “₹1 left. Enough for chai.”
expenses
Why It Matters
• Investors use it to judge profitability.
• Managers use it to make strategic decisions.
• Accountants use it to prepare taxes.
• You use it to know if you can afford that extra samosa.
THREE STATEMENT MODEL
Link to Other Statements:
• Net income flows into Retained Earnings in the Balance Sheet.
• Non-cash items (like depreciation) from the Income Statement are
added back in the Cash Flow Statement.
Balance Sheet, also known as a statement of financial position, is one
of the three core financial statements used to assess a company's
financial position at a specific time period allowing for comparisons.
It shows,
Assets – what the company owns
Liabilities – what the company owes
Equity – the owner’s stake in the business
It follows the golden equation:
Assets = Liabilities + Shareholders’ Equity
This formula is the backbone of accounting. If it doesn’t balance,
something’s fishy.
Components of the Balance Sheet
Assets
Type Examples
Current Assets Cash, accounts receivable, inventory
Property, plant, equipment, long-term
Non-Current Assets
investments
Assets are listed in order of liquidity—how fast they can be turned
into cash.
THREE STATEMENT MODEL
Liabilities
Type Examples
Current Liabilities Accounts payable, short-term loans
Long-term debt, deferred tax
Non-Current Liabilities
liabilities
These are obligations—aka the “IOUs” of the business world.
Shareholders’ Equity
Component Meaning
Common Stock Initial investment from owners/shareholders
Retained Earnings Profits reinvested into the business
This is what’s left for the owners after all debts are paid.
Ratios Derived from the Balance Sheet
Ratio Formula Purpose
Measures short-term
Current Ratio Current Assets / Current Liabilities liquidity
Debt-to- Total Liabilities / Shareholders’ Assesses financial
Equity Equity leverage
(Cash + AR + Marketable Securities) Tests liquidity without
Quick Ratio / Current Liabilities inventory
These ratios help you go from “Hmm” to “Aha!” in financial
analysis.
Link to Other Statements:
• Cash in the Balance Sheet comes from the ending cash in the Cash
Flow Statement.
• Retained earnings include prior net income from the Income
Statement.
THREE STATEMENT MODEL
A Cash Flow Statement shows how cash moves in and out of a business
over a specific period. It is one of the three main financial statement,
alongside balance sheet and income statement. Unlike the income
statement (which includes non-cash items), this one focus purely on actual
cash.
It's crucial because a profitable company can still go bankrupt if it
doesn't have enough cash to pay its bills.
Importance of Cash Flow Statement
✓ It assesses whether a company has enough cash to meet its short-
term obligations and sustain operations through liquidity
assessments.
For Eg – Cash Ratio, Current Ratio, Quick Ratio
✓ Investors & Creditors can determine the financial stability of a
company and its ability to generate cash & repay in future.
✓ Patterns of cash flows aid in making informed financial decisions,
budgeting, forecasting and investment planning.
✓ clear view of profitability, liquidity, and solvency.
Types of Cash Flow Statement
• Direct Method – with cash receipts & cash payments.
• Indirect Method - with net income and adjusts for non-
cash items (like depreciation) and changes in working
capital.
Components of the Cash Flow Statement
✓ Operating Activities.
✓ Investing Activities.
✓ Financing Activities.
THREE STATEMENT MODEL
Operating Activities
✓ Cash from core business operations:
➢ Cash received from customers.
➢ Cash paid to suppliers and employees.
➢ Taxes paid.
Indirect Method: Starts with net income and adjusts for non-cash items
(like depreciation) and changes in working capital.
Investing Activities
✓ Cash used for or generated from investments:
➢ Purchase/sale of equipment.
➢ Buying/selling long-term assets.
➢ Acquiring other businesses.
Financing Activities
✓ Cash from borrowing or equity:
➢ Loans taken or repaid.
➢ Issuing shares.
➢ Paying dividends.
Link to Other Statements:
• Starts with Net Income from the Income Statement (indirect
method).
• Adjusts for changes in Balance Sheet items like receivables,
payables, inventory.
• Cash from debt or equity, and dividends paid.
• Ending cash flows back into the Balance Sheet.
In summary, a cash flow statement is essential for understanding a
company's cash management and financial performance, providing
insights that are crucial for effective financial planning and analysis.
THREE STATEMENT MODEL
Why It Matters
• Liquidity Check: Can the company pay its bills?
• Growth Potential: Is it investing in future expansion?
• Financial Strategy: How is it funded—debt or equity?
How to Build It (Step-by-Step)
1. Gathering Input Historical Data – Collect the company's historical
financial statements to establish a baseline for projections.
2. Set Assumptions – Make assumptions about future growth rates,
expense margins, and capital expenditures based on historical
performance and market conditions.
3. Forecast Income Statement – Project the income statement,
balance sheet, and cash flow statement for a specified period
(usually 5-10 years) based on the input assumptions.
4. Forecast Balance Sheet – Project the balance sheet for a specified
period (usually 5-10 years) based on the input assumptions.
5. Forecast Cash Flow – Build a cash flow statement for a specified
period (usually 5-10 years) based on the input assumptions.
6. Link Everything - Ensure that the three statements are
interconnected, allowing changes in one statement to
automatically reflect in the others.
Building a three-statement model involves forecasting each of these
statements and ensuring these links remain intact. It allows you to
analyse a company's past performance, make projections about its
future, and assess its financial health. And sometimes, when the numbers
don't quite add up, it can be just as funny as a sock-folding origami
swan!
THREE STATEMENT MODEL
Real World Finance Case Studies & References
Walmart – Driver-Based Forecasting
Challenge: Improve financial planning amid inflation and supply chain
issues.
Solution: Linked operational drivers (e.g., foot traffic, fuel prices) to
financial outcomes using predictive models.
Outcome: +22% faster planning cycles, ₹1.1 billion in savings, and
improved forecast accuracy.
Hertz – Debt & Equity Restructuring
Challenge: Navigating bankruptcy during COVID-19.
Solution: Strategic use of debt and equity to maintain fleet operations.
Outcome: Restructuring led to recovery and investor confidence.
Dell – Working Capital Optimization
Strategy: Streamlined inventory and receivables to reduce cash
conversion cycle.
Impact: Improved liquidity and operational efficiency.
Vermont Telecom – Valuation with vs. without Working Capital
A detailed example from Toptal illustrates how using a full three-
statement model can significantly alter valuation compared to relying
solely on the income statement.
For the fictional "Vermont Telecom," incorporating net working capital
dramatically shifts the enterprise value from approximately $602
million down to $483 million, a 22% difference.
Why It Matters: This case underscores the importance of modeling
working capital to avoid gross overvaluation in discounted cash flow
(DCF) models.