Financial Model of a Company
Now that you have learned to build a financial model based on personal finance, it will be easier for you to grasp the concept of financial modeling at the company level. So let us dive into it.
A Financial Model on a company helps an individual to represent the business operation of that company using a spreadsheet. It is a summary of the overall business’s costs, income which can be used to make vital decisions in future.
The flow would be -
There are three main financial statements that need to be studied for financial modeling.
- Income Statement
- Balance Sheet
- Cash Flow statement
Income statement is the financial document that measures a company's financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business earns and incurs its revenues and expenses through both operating and non-operating activities.
The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported. It also contains the numbers most often discussed when a company announces its results - numbers such as revenue, earnings and earnings per share. It shows that at the end of the day, whether or not a business has generated any profits.
The layout of an Income Statement is governed by the accounting standards and reporting requirements applicable to each entity. It is also governed by the choices the entity makes (within the boundaries of its reporting requirements) as to how it structures the presentation of its revenues and expenses on its Income Statement.
Balance Sheet highlights the financial condition of a company. It offers a snapshot of the company's health. It tells us how much a company owns (assets) and how much it owes (liabilities). The balance sheet is named by the fact that it represents a business' financial structure balances in the following manner:
Assets = Liabilities + Shareholders' Equity
Cash Flow statement is a document which provides aggregate data regarding all cash inflows of a company from both its ongoing operations and external investment sources and all cash outflows on account of business activities and investments during a given quarter or year. It shows the true cash or liquidity position of a company.
Companies produce and consume cash in different ways, so the cash flow statement is divided into three sections: cash flows from operations, financing and investing.
1) Cash Flow from Operating Activities (CFO) includes transactions from all the core or operational activities of a business. It shows how much cash comes from sales of the company's goods and services, less the amount of cash needed to make and sell those goods and services.
2) Cash Flow from Investing Activities (CFI) largely reflects the amount of cash the company has spent on capital expenditures, such as new equipment or anything else needed to keep the business going. It also includes acquisitions of other businesses and monetary investments.
3) Cash Flow from Financing Activities (CFF) describes the cash associated with outside financing activities. Sources of cash inflow would be cash raised by selling stock and bonds or by bank borrowings. Likewise, paying back a bank loan would show up as a use of cash flow, dividend payments and common stock repurchases.
Summarising the three Financial Statements –
We can summarise the three financial statements in the following points –
- Keeps track of the revenue and expenses
- The top line is revenue, and the bottom line is net income after dividends
- It is also known as P&L (Profit and Loss) Statement.
- A record of the company’s holdings: its assets, liabilities, and equity at the end of the reporting period.
- It is a snapshot of the company over a time period.
- Total Assets = Total Liabilities + Shareholder’s Equity
CASH FLOW STATEMENT
- Shows how cash is being used during an accounting period.
- There are 3 categories – Cash from operating activities, Cash from investing activities, Cash from financing activities
Flowchart of Interlinks Among the Three Financial Statements
(1) PPE is Plant, Property & Equipment
(2) Sources of cash from decreases in assets or increases in liabilities between this year and prior year (e.g, sale of assets, new debt).
(3) Uses of cash from increases in assets or decreases in liabilities or equity between this year and the prior year (e.g, buildup of working capital, repayment of debt).
The Net Income that is calculated at the end of the Income Statement is used as the starting line item for the Cash Flow Statement. It is also transferred to the Retained Earnings account in the Liabilities side of the Balance Sheet.
Another representation is as follows –
In the above figure,
Net Profit After Tax (NPAT) of ₹72 from the Income statement is added to the Opening Retained Profits to calculate the Closing Retained Profits in the Balance Sheet.
Changes in Cash held in Cash Flow Statement is the sum of Operating Cash Flows, Investing Cash Flows and Financing Cash Flows
₹172 = 247 + (175) + 100
This is added in the opening cash in the balance sheet.