Three-Statement Model

A three-statement model forces internal consistency. Standalone projections of revenue or EBITDA can hide impossible assumptions — a company can't grow revenue 40% with no working capital build or capex. Linking the statements surfaces those tensions: aggressive growth shows up as a cash drain on the balance sheet and cash flow statement, telling you whether the company needs to raise debt or equity. Bankers use the integrated model as the engine for valuation (it produces the free cash flows a DCF discounts), for credit analysis (it generates the leverage and coverage ratios), and for scenario work. If you can't build a clean three-statement model from a blank sheet, you can't do anything else in modeling.

There are three core links. (1) Net income from the bottom of the income statement flows to the top of the cash flow statement and is added to retained earnings on the balance sheet (net income minus dividends). (2) The cash flow statement reconciles non-cash items (D&A added back), working capital changes (from the balance sheet), capex, and financing activities to produce the change in cash — and that ending cash balance becomes the cash line on the balance sheet. (3) The debt schedule and depreciation schedule feed interest expense and D&A back into the income statement. Build order matters: project the income statement down to EBIT, build supporting schedules (D&A, working capital, debt, PP&E), then complete the cash flow statement, then plug ending cash and debt balances into the balance sheet.

The single test of a correct three-statement model is that the balance sheet balances in every projected period — total assets equal total liabilities plus shareholders' equity. If it doesn't, there is a linking error (see balance sheet doesn't balance). A second sanity check: the cash flow statement's ending cash should tie exactly to the balance sheet cash line. A third: any circularity from interest expense (interest depends on debt, debt depends on cash flow, cash flow depends on interest) is handled with either a circular reference and iterative calculation or a copy-paste interest switch.

A typical model runs 5 years of projections with historicals for context. Revenue is built with driver-based forecasting (price x volume, or growth rates). Margins (gross, EBITDA) are projected as percentages. Working capital is driven by days ratios — days sales outstanding, days inventory, days payable outstanding. Capex is often a percent of revenue, and depreciation runs off a PP&E roll-forward. Debt paydown and interest run off a debt schedule. The cash balance (or a revolver) acts as the plug that makes everything tie out.