Getting started with the project

Building a financial model requires getting your hands dirty by actually demonstrating what will happen in a scenario, using figures and projections in Excel. Throughout this course, I will try to keep us all on the same page by using partially prebuilt Excel examples. 

Let's dive in to one of those examples, shall we? I'm in the 01_07.Begin Excel file. Now what you're going to see here is that we have an income statement, a balance sheet, and a statement of cash flows for a firm. All three of these are linked together based on different formulas. So some portions of any financial statements will be driven by data from the firm, something like COGS, as an example, or SG&A, particularly on a historical basis. These won't be projections or calculations; they'll be derived directly from what the firm actually reports. Other items, like Operating Income or Net Income, might be derived from various subsections of the income statement, the balance sheet, or the cashflow statement. Moreover, when we look at the cashflow statement, this in essence reconciles the income statement and the balance sheet with the cash balances of the company. Thus it's frequently going to draw from the other two statements. This is the beauty of a three-statement financial model. In this particular case, we're making various assumptions about what's going to happen to the firm over time, but most of our items are drawn directly from other places in the financial statements. 

A good financial model needs to have clean, clear linkages between all three of your financial statements so that it's easy for outsiders to read. When we get done, we should be able to understand what's happened to that firm over time based on the financials. In the case of this particular firm, we can see that the firm has a rapidly increasing cash balance. They're holding a lot of cash on hand, and they're growing very rapidly. The nice thing about doing all of this in Excel is that if we were to go through and change any of these numbers, let's say we were to adjust out net income from the income statement, it should dynamically update across all of our other financial statements. And that's exactly what we see. So our ending cash balance is adjusted based on the change that we made in the income statement to net income. At this point, you should have a good grasp on the mechanics of financial statement linkages and how different data points fit together through formulas in Excel.