Before undertaking the construction of a financial model, it is important to understand the usefulness of each of the financial statements. This section provides a refresher on Balance Sheet, Income Statement and Cash Flow Statement.
It is the most important financial statement yet it is sometimes absent from financial models. The Balance Sheet acts as a check to make sure the model works correctly and that no cash appears or disappears somewhere in the spreadsheets. It must be balanced at all times.
The Balance Sheet is a photography of the state of a Company at a given point in time, it reports what the Company owns (assets) and how it was funded (liabilities).
Even if the project being modeled will not have a dedicated special purpose vehicle and will be borne by the company undertaking it, it is essential to include a Balance Sheet in the financial model to make sure the model works correctly.
Below is a simplified representation of a Balance Sheet and how it can be reorganized to calculate the Capital Employed.
Income Statement (also known as Profit and Losses, or P&L)
The Income Statement reports the operating performance of a company over a given period of time, the bottom line of the Income Statement is the Net Income and it can show either a profit or a loss.
The profit or loss reported by the Income Statement is an accounting indicator, it it does not give any indication regarding the cash flow generation capacity of the Company.
Below is a simplified representation of an Income Statement.
Cash Flow Statement
The Cash Flow Statement reports how the cash is generated (or burned) by the Company, it is broken down between Operating, Investing and Financing Activities.