If I Could Go Back and Change One Thing...

Three Statement Model: I'm not going to bury the lead here.

If I could go back and learn one thing, it would be this: learn the three statement model sooner.

Why? Because understanding three statement modeling fundamentally changed how I think about business. Today, I can build in hours what used to take weeks.

Everything else -- fancy Excel formulas, VBA, custom templates -- doesn't even come close.

The Night It All Fell Apart

Back in 2011, I was coming off a six-month (mostly onsite) client engagement in Virginia.

(it was in hospitality, so let's call it "HotelCo")

I was back in New York City at my consulting job getting staffed on a new project.

I'm sitting in our Times Square office at 7 or 8pm, when one of our MDs walks over:

"Hey, we've got this distressed client that needs a three statement model in the next few days. You built one for HotelCo right? You're our guy."

"At HotelCo that model took us months," I said, "and this needs to be done in a couple of days?!"

(I still remember the panic feeling crawling up the back of my neck)

In truth, I was really proud of the work on did on HotelCo, but for that project I also had guidance from a senior team member. We collaborated on the structure, and while I contributed a ton, I wasn’t the architect of the entire thing.

So when the MD made that request, I felt completely out of my depth.

The Crash and Burn

Nonetheless, I tried my best to get started -- slapped together some half-baked attempt that tried to tie the Income Statement and Balance Sheet together (for the historical financials only), and left tons of holes and yellow highlight cells in the Statement of Cash Flows.

Plainly, it was a wreck: nothing balanced, no forecast structured, and I was beyond stressed.

It was super late at night, and I'd barely made any progress.

Lucky Break

Fortunately for me (and this was common back then, especially post-Financial Crisis), a day or two later, that client completely shifted course and no longer needed this "urgent model." (🤦‍♂️)

I was frustrated, sure, because of the wasted time I'd spent on the model (not to mention the stress), but for the most part I was relieved.

Commitment to Learning

There's no way to sugarcoat this: that feeling completely sucked.

But, having just caught a lucky break, I decided I only wanted to learn that lesson once.

So, I committed to really mastering three statement modeling -- not just build one illustrative model, but practice it until it became second nature.

That meant YouTube videos, online courses, and getting reps.

It finally clicked when I sorted through a few things:

1. Vertical Modeling: stacking all three statements on top of each other (+ support schedules) made the whole thing a million times easier. With one consistent date row along the top, it was much easier to align and connect the Income Statement, Balance Sheet, and Statement of Cash Flows.
2. The Indirect Method: I never quite understood how the Cash Flow Statement was built until I mastered the "indirect method." I learned that all you have to do is pull the Net Income from the Income Statement, and then take the changes in the Balance Sheet for all the other line items (Previous Period - Current Period for Assets, and Current Period - Previous Period for Liabilities & Equity). When done correctly, your ending Cash will match the Balance Sheet.
3. Balancing the Balance Sheet:when your model switches from Actual to Forecast, you only need to make two changes to make the Balance Sheet balance:
   1. Link your Ending Cash to the Statement of Cash Flows
   2. Make Retained Earnings equal to the previous period's balance + the current period's Net Income

4. Knowing What to Ask For:after figuring out the above, I realized the only two things you need to build a three statement model are:

1. The Income Statement
2. The Balance Sheet

A Worthwhile Grind

I continued to work hard build three statement models in my spare time.

Were they perfect? No.

But, little by little I got better at it, learned what to ask for, and started to memorize the steps.

But at the end of the day, everything flows back through the same three statements:

• Tech Company: ARR and Deferred Revenue hit the Income Statement and Balance Sheet
• Real Estate: Complex debt structures hit the Balance Sheet
• Manufacturing: Inventory projections hit the Balance Sheet (working capital)

These days, that MD's request doesn't seem crazy at all. A complete three statement model in a couple days? Totally doable when you understand the architecture.

(and just a few hours to get the plumbing right)

As a result of the work I put in, today, my brain only thinks in the three statements:

• "if Revenue goes up, how does that affect AR and how does that affect Cash?"
• "if we increase our Capex spend, how does that affect our Free Cash Flow and our future Depreciation?"
• "if we receive upfront customer deposits, how does that affect Cash and Deferred Revenue?"

It all comes back to the three statements. Master those, and you can model any business in any industry. They're truly the universal language of business.

That's why, if I could go back and change one thing, I'd learn the three statements sooner. Way sooner. Nothing else has had a bigger impact on my career.

That's it for today. See you next time.
—Chris

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