Three Statement Model Confusion
Kinda confused by two different approaches to three statement modeling I have seen. From one resource, they instructed to project IS future financials, project BS items (independently), and then use the CFS as simply a plug at the end. This makes sense to me.
But from another reputable resource, they say similarly to project IS future financials, but to project some BS items independently (i.e. using drivers like % of Income statement items) but not all BS items. And then for some reason we project directly on the CFS (so it doesn't seem like a simple plug anymore), and some CFS entries that are projected (as % of IS items) are depreciation, amortization, SBC, deferred taxes. And then does CFS assumptions in turn drive some of the BS items.
Most confusing part is that one resource says to just project BS items separately and use CFS as a final plug, but then this other resource says project some BS items separately, but then project CFS and let that flow into BS? it seems like the steps are intermixed in this second resource and wondering what is right.
Think it's a bit of a mix. You project what you can on the basis of information you have, and what makes sense to be able to project.
For example, you'd project working capital driving off the income statement given the direct impact of sales on inventory, receivables etc. You wouldn't generally project every BS item with detailed drivers given there are some instances where it can be idiosyncratic.
Unsure what exactly you mean by project BS items independently but think a model you build where assumptions are independent for each statement would be inflexible and fail its purpose of being a model of any use.
Your cash flow items that you'd project would be capex, then both your IS D&A and the capex feeds into your BS PP&E. Generally a company who is aiming to grow faster will spend more on investment capex so tends to be driven off the IS. I can't say I've seen many instances where you'd project PP&E and then pull out capex. You can but you'd want the flexibility of amending investment and maintenance capex assumptions generally so this is usually the driver.
got it, to clarify when i say bs items independently i mean they don't rely on the cfs and rather, the cfs items that are connected to said bs items change according to the beginning vs ending balance of the bs item. so for example, bs items that are forecasted as % of revenue (and not needing any cfs considerations).
Usually it’s the opposite way around you wouldn’t forecast out BS items as a % of revenue it doesn’t make sense to do that except for WC. I don’t recall ever really forecasting the BS out in this much granularity anyway it’s not applicable to most businesses aside from O&G perhaps. It should be the opposite way around anyhow CFS flows into BS not BS flows into CFS
Work on your understanding of the concepts rather than doing it in excel and it’ll make more sense. You’ll understand how to build it and what drives what
I’ve learned both ways - my IB professors prefer to project the IS and build a schedule for every BS item, then link the ending balance on that item to the BS and reference the change in the CFS to balance. In this case, we’d either straight-line the ending balance; set the ending balance as a % of revs, COGS, etc.; or set the change as a %.
My credit professors prefer to project the IS, then project the CFS using DSO, DIS, etc and assumptions for change in BS items, then on the BS just add the last year value to the change from the CFS to get the ending value.
In practice, they do the same thing, it’s just about where you store your assumptions - I prefer the IB method as it’s easier to see and balance the BS (the credit ones can get messy, as some assumptions are on the CFS and some on the BS), but both work.
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