Steve's Financial Modeling Tutorial

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Model Basics
Income I
Income II
Balance Sheets
Corporate Tricks I
Corporate Tricks II
The basic financial statements

There are three basic financial statements:
Balance Sheet
Income Statement
Cash Flow Statement

You need to create ALL THREE of these statements to have a real financial model.  Most people only know how to model income.  For example, "I will make computer chips for .50 cents each and sell them for .75 cents each."  This is only the income and costs, not the whole story.

You need to show how your company will finance itself, how it will account for important things like inventory and what your balance sheet looks like.



GAAP stands for Generally Accepted Accounting Principles.  These are the rules that accountants are supposed to follow when they perform audits.  Of course, since accounting is necromancy, GAAP is the n.  Like the Koran, it is simply interpreted by accountants to fit their needs, though some rules are pretty hard and fast.  You don't need to follow GAAP when creating a financial model.  In fact, you can't follow GAAP when creating a financial model because you wouldn't have enough information and your model would be come too complex and would not be a useful predictor of financial performance.  But you could try if you like self-flagellation.

FASB is the Financial Standards Accounting Board. This is the coven that sets all those accounting rules.  The SEC defers to FASB on accounting rules.  You really don't need to worry about FASB when modeling, unless you want to watch their initiation ceremony, which I hear includes raw shellfish and under inflated volleyballs.


The balance sheet represents the financial state of the company at a specific moment in time. It is important to realize that the balance sheet of a company changes from day to day and moment to moment. It is usually prepared at a minimum of once per year.

Companies operate on a fiscal year, which is usually 12 months and probably ends at the end of a quarter (March 31, June 30, September 30 or December 31). At the end of the fiscal year, companies hire accountants to prepare financial statements. The balance sheet is prepared as of the end of the fiscal year. It can take many months to prepare a balance sheet, so by the time it is prepared it is already out of date.

The balance sheet has three basic components:

Assets (stuff the company owns)
Liabilities  (amounts the company owes to lenders)
Equity (Amounts the company owes to investors and profit that has accumulated)

You are probably saying "How do I tell the difference between equity and liabilities?"  Or you might be saying "I need another latte now."

I'll go into the differences between equity and liabilities in a later chapter.


The income Statement shows the profit or loss of the company over a specific period of time. At the top of an income statement is the company's revenue, hence the Wall Street jargon of "top line" for revenue. In the middle of an income statement are the expenses of the company, both fixed and variable and any non-cash expenses (more on this later). At the bottom of an income statement expenses are subtracted from revenues and you get a profit figure, hence the Wall Street jargon of "bottom-line" for profit.

The income statement has three parts:

Revenue (amounts you get from selling goods or services aka income)
Expenses (including non-cash charges such as depreciation)
Profit (aka net income)

You are probably asking "What's depreciation?".  Well, I can't tell you or I'd have to kill you.  Just kidding.  I'll explain it in the income statement chapter.


The cash flow statement is the most difficult statement to understand but the easiest to calculate. The cash flow statement includes all cash that is coming into the company, whether it be from revenue or from bank borrowing1. It also shows all the ways cash has left the company, including expenses such as salaries and making investments such as buying real estate.  The cash flow statement is, in some ways, a means of adjusting the income statement to reflect changes in the balance sheet. Or something.

There are two common ways to present cash flows.

Cash Flow #1:

Cash From Operations (income without non-cash charges)
Cash From Financing (borrowings, etc.)
Cash From Investing (stuff you can't expense)

Cash Flow #2:

Sources of Cash (everything coming in)
Uses of Cash (everything going out)


1I believe this is an appropriate use of the subjunctive tense in English.


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