Financial statements are written records that convey the business activities and the financial performance of a company. Government agencies, accountants, firms, etc. are the ones who often audit the financial statements. The main goal is to ensure accuracy and for tax, financing, or investing purposes. Three main financial statements include:
Let’s take a look at each statement in more details.
An income statement (profit and loss account) is one of the financial statements of a company. It shows the company’s revenues and expenses during a particular period. In addition, It indicates how we transform the revenues into the net income or net profit. Often, the first place an investor or analyst will look at is the income statement. Here are some highlights:
The balance sheet displays the company’s total assets, and how these assets are financed, through either debt or equity. Also, we can refer to it as a statement of net worth or a statement of financial position. Here are some highlights:
The cash flow statement reports the cash generated. We use it during the time interval specified in its heading. Generally, the period of time is the same as the income statement. Here what you have to remember:
Financial models use the trends in the relationship of information within these statements. In addition, it uses the trend between periods in historical data to forecast future performance. Here are the steps to follow to create a financial model:
The picture below is an example of the simple one-sheet model using information from all three financial statements. The best practice is to build a simple model in quadrants (shown below). You can learn more about Financial modeling best practices in our article.
A 3-statement financial model is a type of model that forecasts a company’s income statement, balance sheet, and cash flow statement. These are usually on separate Excel sheets. Above all, a key feature of an effective model is that it is “integrated”. In other words, we model the 3-statement models to accurately capture the relationship and inter-linkages of the various line items across the financial statements. Moreover, an integrated model is powerful because it enables the user to change an assumption in one part of the model. The reason is to see how it impacts all other parts of the model consistently and accurately.
All three accounting statements are important for understanding and analyzing company performance. It helps to visualize the situation from multiple angles. For instance, The income statement provides deep insight into the core operating activities that generate earnings for the firm. However, the balance sheet and cash flow statement focus more on the capital management of the firm. It refers in terms of both assets and structure.
To sum up, The three main financial statements are the core for building any financial model of the company. Learn more of Financial Modeling skills and needed for that Excel tricks by playing our educational games keySkillset.
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