Three Financial Statements

The three financial statements are the income statement, the balance sheet and the cash flow statement.

What are the three financial statements?

The 3 financial statements are: (1) the Income Statement, (2) the Balance Sheet, and (3) the Cash Flow Statement.

The core statements in financial modelling are the same core statements in accounting. In a financial model, each of these statements will impact the values within the other statements.

Overview of the three financial statements

#1 Income statement

Often, a great place to start a financial model is the income statement. The statement shows the performance of the business throughout each period, displaying sales revenue at the very top. The statement then deducts cost of goods sold to find gross profit. From here, the gross profit is affected by other expenses and income depending on the nature of the business to reach net income.

#2 Cash flow statement

The cash flow statement then takes net income and adjusts this for any non-cash expenses. Then, using changes in the balance sheet, usage and receipt of cash is found. The cash flow statement displays the change in cash per period, as well as the beginning balances and ending balances of cash.

#3 Balance sheet

The balance sheet displays the company’s assets, liabilities and equity. As commonly known, assets must equal liabilities plus equity. The asset section begins with cash and equivalents, which should equal the balance found at the end of the cash flow statement. The balance sheet then displays the changes in each major account. Net income from the income statement flows into the balance sheet as a change in retained earnings (adjusted for any net income spent on paying out dividends).

How these core statements are used in financial modelling?

As explained above, each of these statements have an interplay of information. Financial models use the trends in the relationship of information within these statements, as well as the trend between periods in historical data, to forecast future performance.

The preparation and presentation of this information can become quite complicated. In general, however, the following steps are followed to create the financial model.

  • Line-items for each of the core statements are set up. This provides the overall format and skeleton that is followed by the financial model’s flow.
  • Historical numbers are placed in each of the line-items.
  • At this point, the creator of the model will often check to make sure that each of the core statements reconcile with data in the other. For example, the ending balance of cash calculated in the cash flow statement must equal the cash account in the balance sheet.
  • An assumptions section is prepared within the sheet, to analyze the trend in each line-item of the core statement between periods.
  • Assumptions from existing historical data are then used to create forecasted assumptions for the same line items.
  • The forecasted section of each core statement will use the forecasted assumptions to populate values for each line item. Since the analyst or user has analyzed past trends in creating the forecasted assumptions, the populated values should follow historical trends.
  • Supporting schedules are used to calculate more complex line items. For example, the debt schedule is used to calculate interest expense, and the balance of debt items. The depreciation and amortization schedule is used to calculated depreciation expense, and the balance of long-term fixed assets. These values will flow into the three main statements.

More resources related to the 3 financial statements

We hope this has been a helpful overview for you of the 3 financial statements, and we believe these articles will help supplement your learning: