Numbers can tell powerful stories. They paint a picture of a company’s past performance. Just as importantly, they can also reveal how that company might perform in the future under different circumstances.
A 3-statement financial model is what transforms these numbers into meaningful insights. It allows finance professionals to evaluate a company’s performance, forecast future results, and make better-informed decisions.
This type of model serves as the foundation for understanding how various decisions impact the overall business.
In this article, we’ll dive deeper into what a 3-statement financial model is and why it matters. We'll also explore how its components connect to provide a cohesive picture of your company’s financial story.
Want a clear, step-by-step guide to building an effective 3-statement model? Check out
CPE Flow’s 3-Statement Financial Modeling Bootcamp. This expert-led course shows you how to build a model to forecast performance and support strategic decision-making.
A 3-statement financial model integrates three key reports into a single, interconnected model. These include the income statement, balance sheet, and cash flow statement.
Many finance professionals use this tool to forecast a company's financial performance and overall health. They can see how various business activities are likely to affect the revenue, profitability, liquidity, and financial position of the business.
The income statement, balance sheet, and cash flow statement are the three financial statements that form the backbone of this financial model.
Financial statements are reports encompassing a company’s financial performance over a specific period of time. Each of these offers unique insights into profitability, financial health, and cash movements of the business.
A key feature of a 3-statement model is that these statements are interconnected, so you can see how a change in one part of the model affects the others.
Let’s take a closer look at each of these core components.
Get Exclusive Access & Special Discounts!
Get early bird access to new CPE courses and exclusive discounts only shared with our email subscribers.
The income statement, also known as the profit and loss (P&L) statement, shows how much money a company earns (revenue) and how much it spends to generate that revenue (expenses). Ultimately, it reveals whether a business is actually profitable or operating at a loss.
The statement begins with the company’s revenue, followed by a deduction of its expenses. Expenses can be directly tied to the products or services sold, such as the cost of goods sold (COGS). They can also include the day-to-day costs of running the business, such as wages, rent, and utilities.
The bottom line of the income statement displays the net income. This represents the profit earned after all costs, expenses, and taxes have been deducted from the revenue.
Essentially, the income statement is crucial for determining whether a company is generating profits and managing its expenses efficiently.
The balance sheet offers a snapshot of what a business possesses and owes to others at a specific point in time.
Think of it as a still photograph that captures the company’s financial position, or net worth, at that exact moment.
It is comprised of three key components:
- Assets: What the company owns that holds value, such as cash, inventory, property, or equipment.
- Liabilities: What the company owes to others, including loans, accounts payable, unpaid wages, or taxes.
- Shareholders’ Equity: The owners’ residual interest in the company after liabilities are subtracted from assets.
The balance sheet is governed by a simple accounting equation: Assets = Liabilities + Shareholders’ (or Owners’) Equity.
This statement helps evaluate a company’s financial stability. This includes its ability to meet short and long-term obligations, pay off debt, and generate long-term value for its shareholders.
The cash flow statement demonstrates how cash moves in and out of the business over a specific period of time.
It tracks cash activity across three areas: operating, investing, and financing. This provides a clear picture of where money is coming from and how it’s being used.
Essentially, this statement reflects the company’s liquidity and overall financial health, including its ability to fund daily operations and pay off debt.
A 3-statement financial model is a key tool to support financial analysis and decision-making.
Here are some key functions and applications of the 3-statement model:
- Forecasting performance: Companies can use historical data to build assumptions about future performance. By adjusting variables such as sales growth, operating expenses, and capital investments, they can assess the impact of different scenarios on profitability, cash flow, and overall financial health.
- Supporting decision-making: Business leaders and finance professionals can analyze how specific decisions, such as pricing strategies, hiring plans, capital expenditures, or debt management, affect the company’s financial outlook. This helps them make more strategic decisions to improve the company's performance.
- Enhancing risk management: A well-built model enables businesses to test both best-case and worst-case scenarios, assess financial risks, and plan ahead to ensure resilience in changing market conditions.
- Improving valuations and investor communication: 3-statement models present a clear, cohesive view of the company’s current position and future potential. This transparency helps investors and stakeholders better understand the company’s ability to generate cash, meet obligations, and create long-term value.
In short, a 3-statement model transforms raw data into actionable insights, enabling you to make better financial decisions in the long run.
Building a 3-statement financial model can be quite complex, but it follows a logical flow.
The aim is to create a dynamic tool that connects the income statement, balance sheet, and cash flow statement.
Here’s how it generally works:
Every financial model begins with collecting historical financial data, such as revenue, expenses, and cash flow.
From there, you can establish key assumptions about the company’s performance, including its revenue growth, operating costs, working capital, capital expenditures, and profit margins. These assumptions should be grounded in historical trends, market research, and the company’s strategic goals.
Together, they enable you to forecast future results and assess the impact of different scenarios on your company's financial performance.
The income statement serves as the foundation of a financial model, showing how revenue translates into profit over time.
You can build an income statement forecast by projecting revenue based on historical data and key assumptions such as price, volume, and growth rate.
From this, you can subtract the cost of goods sold (COGS) to calculate gross profit. Next, estimate operating expenses. Finally, deduct interest expenses and projected taxes to arrive at net income.
The next step is to build the balance sheet, which is a summary of the company’s assets, liabilities, and equity at a specific point in time.
Start by updating retained earnings using the net income from the income statement. The balance sheet should also account for any capital expenditure and depreciation.
You can also update any debt balances based on repayments or new borrowings.
The cash flow statement is the final core component of the model, linking together the income statement and balance sheet. It tracks how cash moves in and out of the business across three key activities, which are operating, investing, and financing.
This statement shows how changes in working capital, capital expenditures (CapEx), new borrowings, and debt repayments impact the company’s liquidity.
The final step involves connecting the income statement, balance sheet, and cash flow statement. This integration allows you to see the full ripple effect of any assumption or adjustment.
For example, net income from the income statement flows into retained earnings on the balance sheet and the operating section of the cash flow statement. Meanwhile, capital expenditures reduce cash in the investing section while increasing property, plant, and equipment (PP&E) on the balance sheet.
Once all links are correctly established, a change in one section should automatically update in all three statements. This gives you a holistic, real-time view of the company’s financial health and the impact of different decisions.
Building a reliable 3-statement financial model is more than just linking numbers across different sheets. It requires a solid understanding of how the income statement, balance sheet, and cash flow statement work together to paint a complete picture of a company’s financial health.
Some best practices include keeping assumptions transparent, using color coding to differentiate inputs and formulas, maintaining consistent data formatting, and avoiding hardcoded numbers wherever possible.
Above all, aim for clarity. Since financial models are often shared and reviewed by multiple parties, your model should be well-structured, easy to follow, and intuitive for others to use and audit.
This self-paced course walks you through translating business operations into financial assumptions, modeling working capital, investments, debt, and equity, and linking everything seamlessly across all three statements. And best of all, you can also earn NASBA-approved CPE credits while developing these skills!
Nathan Liao, CMA
Empty space, drag to resize
Nathan Liao, a Certified Management Accountant, educator, and influential business figure in the accounting industry, has dedicated over a decade to supporting more than 82,000 accounting and finance professionals in their pursuit of the CMA certification. As the visionary founder of CMA Exam Academy and CPE Flow, Nathan is committed to delivering premier online training solutions for the next generation of accounting and finance professionals.
