We all know cash is king in keeping your business alive. As distribution and manufacturing organisations continue to face supply chain constraints, the rising cost of raw materials and late paying customers — cashflow is an ongoing concern.
While many business people are busy addressing these immediate cashflow issues, others are also turning to the 3-statement financial models to ensure the cash measure is accurate now, in a year, and how it might hold up as they plan into the future.
What is a 3 statement financial model?
A three statement model is an integrated model that links financial statements to forecast income statements, balance sheets and cash balances for a company.
What is the best way to create a 3-statement model?
The 3-statement model has always been invaluable but is complicated to execute using spreadsheets. If you want to link the 3 statements, you can now use a business planning and analytics platform to connect your three statements and all data flowing into these live statements. This means every time changes are made to the balance sheet or profit and loss statements, they automatically flow into the cashflow statement — providing a more accurate picture of your company’s financial position and how certain decisions can impact cashflow.
When the income statement (profit and loss), balance sheet, and cash flow statement are linked into one dynamically connected financial model, decision-making is clearer because you can cross-check growth, profitability and cashflow against drivers that are important to your business – delivering the gold standard in financial planning & analysis (FP&A).
Types of 3-statement models
Let’s explain the difference in developing the 3-statement financial model in an excel template compared to custom-made software like Phocas - a business planning and analytics platform that specialises in financial planning.
Any ‘old school’ finance manager will tell you there’s a valuable lesson in building the model. The beauty of using software to achieve this is that you still maintain the learning exposure, but without all the broken formulas and drawbacks. Phocas product specialists and developers worked with finance professionals to ensure the model was robust and the structure was clean with the use of 3 built-in mini drivers covering (stock, debtors days and creditors) and the ability to create further custom drivers for your needs. These templates have pre-built lines with basic inputs for a calculation. These templates have pre-built lines with basic inputs for a calculation. They allow you to quickly model common interactions between your Profit and Loss (Income Statements) and Balance Sheet items without having to manually enter formulas.
The mini drivers represent the links between your statements when using 3-way modelling in Phocas. The mini drivers can be used to forecast or budget your Balance Sheet items like the average length of your debtor days, so your Cash Flow better reflects reality.
Accountants certainly know their way around a spreadsheet but building a 3-statement model takes sophisticated skills where spreadsheets need to be joined, creative logic applied, and formulas are corkscrewed or chunked up for ease of management. Imagine all formulas, written in plain English, unbreakable and ready for you to select.
If you opt for a custom model, choose one that can be built on a data platform so that your three statements representing your consolidated data, budgets and month end are connected. Get the benefit of daily or hourly sales, operational and financial data drawn in from your ERP, CRM, ecommerce and inventory systems all in the one place.
A cashflow forecast is more accurate and has financial integrity when it is driven by real-time data in the balance sheet and P+L (income) statement.
How does a 3-statement financial model help with planning?
Another benefit of implementing a 3-statement model using custom made software is you can plan effectively. The model gives an accurate picture of how changing your business strategy will affect the income statement (profit and loss) and balance sheet but most importantly your cashflow.
Businesses are being hit with multiple challenges at the same time so knowing how these issues affect cashflow today as well as in 6 months and 12 months takes a lot more focus and effort for finance leaders.
When making complex economic decisions, a 3-statement financial model gives the most certainty.
Let’s say, for example, an Australian manufacturing business creating natural medicines is finding the challenges in the market much tougher than they have experienced before (sound familiar?). Demand is strong but the company continues to deal with lingering short-term issues like global supply change delays, inflation and labor shortages.
While effectively operating day to day is difficult, the owner knows that to stay viable in the long term he/she also must address some broader issues now.
Top of mind is the need to replace legacy business systems to enhance the go to market strategy and address changing customer preferences.
There is much to consider in this business and it’s difficult to decide where to concentrate the effort but by using an automated 3-statement model the manufacturer can see how financial ad operational changes will affect the big picture and give him/her direction.
The model can help the business leader to answer a range of questions like:
- How does hiring more salespeople and upgrading the CRM system impact the bottom line in 6 months and 12 months?
- What does profitability look like when throughput is slow for the next 12 months?
- Will the business be generating enough cash flow to cover the cost of new staff and pay back increased debt from investing in new systems.
- The impact of different accounts payable and receivable terms have on cash flow
…and give the business leader and his/her team the confidence to move forward.
Strong economic decision-making is enhanced with the full picture. Software that enables you to build a well-structured financial model with an integration of three financial statements (3-statement model) makes this much easier. If there is a change in one financial statement, the other financial statements adjust accordingly so ongoing analysis is accurate and clear.
Katrina is a professional writer with experience in business and tech. She explains how data can work for business people without all the tech jargon. She is always on the look out for new ways data is being used by business people to know more and be sustainable.
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