Financial accounting is an essential function of any successful business. As technology advances, more and more businesses are turning to 3-Way Modeling to make their auditing processes easier and more efficient.
3-Way Modeling is a method of accounting that uses three separate model templates to track financial information. The three models are the balance sheet, the income statement, and the cash flow statement. By using these three models together, businesses can create an auditable financial model that accurately reflects the company's overall financial situation.
Definition of 3-Way Modeling
3-Way Modeling is a three-dimensional approach to financial information. This method uses three separate models to track data. The three models are:
- Balance Sheet: tracks the company's assets and liabilities.
- Income Statement: tracks the company's income and expenses.
- Cash Flow Statement: tracks the company's cash inflows and outflows.
Benefits of 3-Way Modeling
The primary benefit of 3-Way Modeling is it makes auditing financial information more accurate, efficient, and cost-effective. By using a three-dimensional approach, auditors can get a complete picture of a company's financial situation and pinpoint areas that need improvement. Additionally, 3-Way Modeling allows companies to create an auditable financial model that accurately reflects the company's overall financial health.
- 3-Way Modeling is a three-dimensional approach to financial information.
- It uses three separate models to track data - the balance sheet, the income statement, and the cash flow statement.
- The primary benefit of 3-Way Modeling is it makes auditing more accurate, efficient, and cost-effective.
- Businesses can create an auditable financial model that accurately reflects the company's overall financial health.
Define Model Inputs
Financial modeling begins by setting the model's inputs. This includes forecasting the budget and gathering other related data that is integral to the overall model. To create auditable financial models with 3-Way modeling, the following inputs should be considered:
In any financial model, the budget contingency sets the boundaries and the behavior of the outcome based on the assumptions taken. Budget contingencies are created by considering the magnitude of the project, stakeholder buy-in, and competitors. With 3-Way modeling, budget contingencies must be considered based on the availability of resources and their probability of success. This allows for regular forecasts and accurate financial models.
In 3-Way modeling, probability variables inform the auditing process of a financial model. Probability variables allow for stakeholders to hedge their risks by considering the various scenarios of the model's outcomes. Common probability variables include the success rate of the project, the number of iterations of the model, and the effect the current economic climate has on the decisions.
Forecasting plays an important role in auditing financial models with 3-Way modeling as it helps to identify patterns or trends that can be capitalized on. Forecasting in 3-Way models includes analyzing historical data, revenue and cost differentials, and potential risks. For auditors, forecasting helps to identify any potential weaknesses in the model and helps to predict future growth.
Financial models with 3-Way modeling require accuracy in their input calculations in order to be successful. With careful consideration of budget contingencies, probability variables, and forecasts, auditors can effectively create auditable financial models.
Creating a financial model that’s accurate, auditable and reliable requires a thorough understanding of the underlying assumptions. To ensure that any financial model can yield meaningful insights, it’s important to take the time to clearly define the assumptions within the model.
Research Market Trends
Researching relevant market trends is an important step in clarifying any assumptions within a financial model. Taking the necessary time to become familiar with the industry and how economic indicators might affect revenue can help build a more reliable and accurate financial model. Once you’ve identified any specific trends, you’ll be able to more confidently incorporate them into the three-way model.
Calculate Price Points
Part of creating a financial model involves evaluating how estimated price points will affect the bottom line. Estimating the total cost of goods sold and creating accurate assumptions about hard and variable costs will allow you to accurately predict what price point could generate the most profit. If your business is selling products or services, it’s important to take into account a competitive analysis of competitors' pricing as well, as this could have an effect on forecasting and modeling assumptions.
Make Logical Assumptions
Once you have a good understanding of where the market is and have calculated the expected price points, you can begin to make logical assumptions about how much you can or should charge for your product or service. This can help determine pricing for other products or services and inform future decisions about expanding a business. Additionally, some logical assumptions should be made about production, customer acquisition and other areas of the business so that all outcomes are accounted for in the financial model.
- Research relevant market trends
- Calculate price points
- Make logical assumptions
Analyze Model Outputs
To create auditable financial models, it is important to analyze and interpret the output that the model produces. Analyzing the output helps to identify errors, track performance, and, ultimately, weed out any inconsistencies in the information given to the model. The following sections provide an overview of how to analyze outputs to understand a financial model's accuracy and soundness.
Compare Assumptions to Market Benchmarks
When analyzing model outputs, it is important to compare the assumptions used in the model to market benchmarks. This helps to verify the accuracy of the model by confirming that the assumptions used are in line with what is expected for the market. Additionally, market benchmarks can serve as a reference point for running “what-if” scenarios. For example, what if a specific input or assumption was changed - how would it affect the outputs? Comparing model assumptions to market benchmarks can serve as a valuable tool for understanding the model's accuracy.
Analyze Changes in Tested Variables
The second step for analyzing model outputs is to analyze the changes in the variables tested through the model. This is necessary to understand how the outputs of the model will change under different circumstances. By understanding how the results of a certain change in the model affects the outputs, the user is more capable of using the model in different situations. This analysis also helps to identify errors in the model if one test produces anomalous results.
Monitor Performance Metrics
When analyzing model outputs, the user should also monitor key performance metrics used to measure the success of the model. This could range from profitability metrics like net income, total revenue, or customer satisfaction metrics like customer churn rate. By tracking performance metrics, the user can ensure that the model is functioning as intended and that the results are accurate. Additionally, tracking performance metrics can help to identify areas of improvement in the model itself.
Analyzing the outputs of a financial model is necessary to ensure accuracy and precision of the results. By comparing the assumptions used in the model to market benchmarks, analyzing the changes in tested variables, and monitoring performance metrics, the user can ensure the model is generating trustworthy results. Ultimately, this will help to build an auditable financial model.
Audit for Accuracy
Auditing the accuracy of your financial model is an essential step in the process of building. Whether you are creating a detailed financial statement forecast spreadsheet or a more basic sensitivity analysis, it is important to ensure accuracy across the model. There are several ways of going about a financial statement audit, including testing data optimization, reviewing outputs for inaccuracies, and debugging scripts for data discrepancies.
Test Data Optimization
The first step of auditing for accuracy should be to test different inputs for optimization. This is especially important for large and complex financial models. To do this, run calculations with different data sets and then compare the results. This can help ensure that the type of data being used in your model is appropriate and that it is yielding accurate results.
Review Outputs for Inaccuracies
In addition to testing data optimization, it is important to review the outputs of your financial model for any inaccuracies. This includes running key calculations and reviewing the underlying assumptions to ensure they are properly embedded in the financial model. This can help identify any errors and help you quickly address and correct them.
Debug Scripts for Data Discrepancies
Finally, it is important to debug scripts to identify and address any data discrepancies that may arise. Scripts should be tested in a variety of different situations to ensure they are running properly and delivering accurate results. Debugging is a time consuming process, but it is important to ensure accuracy across the entire model.
Organizing and documenting the results of your financial model is a critical step for creating an auditable model. Such documentation should help you as you remember inputs and outputs for decision-making as well as explain to others the methodology used to compiling the model. Below, we’ll explore three of the best methods for properly documenting results.
Take Notes of Modeling Process
While conducting the process of 3-way financial modeling, you should make sure to take notes. This helps to ensure that you have a record of both the inputs and the outputs at each step. This can also be used to explain the methodology when showing others your modeling results.
These notes could take the form of a quick summary of the prediction or a more detailed explanation of what inputs were used, which assumptions were made, and how the result was determined. Notes can be simple to-do lists or narratives explaining various components of the model.
Record Results in Organized Database
Organizing results in a simple database, such as a spreadsheet, is an effective way to document the results of your model. This makes it simple for you and your team to analyze and access the results of your modeling. Additionally, because spreadsheets are widely used and adaptable, you have a lot of options for organizing your data.
You may choose to keep one master spreadsheet where all results are recorded or break the document into several pieces with different worksheets or tabs. You can also organize the data into rows and columns, separating inputs and outputs in a way that’s easy to comprehend. Additionally, you can use a combination of formulas, text, and images to record the information.
Archive Detailed File Names
Finally, once you have saved your specifically named financial model files, it’s important to store them on a secure server with accurate descriptions and versions of the model to ensure you have a record of the different versions you have created during the process. Keeping detailed file folders can help you avoid confusion.
Archive organizational files and structure should remain consistent. This means that files for a similar operation should be archived together and given the same name. This provides continuity to the project when it is passed on to different teams or institutions.
When it comes to auditing financial models, the use of 3-Way Modeling can offer a range of benefits that make it an invaluable tool. It enables the user to fulfill their audit objectives more efficiently, providing greater accuracy and insight into the financial situation.
Summary of Modeling Process
3-Way Modeling offers an in-depth view of the data, enabling users to create a detailed financial audit that is often more accurate and comprehensive than more traditional types of modeling. It involves three key elements: inputs, outputs, and statistical analysis. By combining these three components into a single unified model, users can create a cost-effective and reliable audit.
Benefits of Using 3-Way Modeling
Using 3-Way Modeling to audit financial models offers a variety of advantages, including:
- Able to quickly identify patterns, trends and relationships that are often missed by traditional approaches.
- Provides more accurate analysis of financial data and allows for improved decision making.
- The use of statistical analysis allows for more accurate predictions about potential problems.
- It is cost-effective and can be completed in a shorter amount of time.
Long Term Financial Advantages
In the long term, using 3-Way Modeling can provide a number of financial advantages, such as reducing the risk of costly errors, improving the accuracy of financial decisions, and providing better insight into the financial health of a company or organization. Furthermore, using 3-Way Modeling can help to protect a company’s reputation and foster better relationships with clients, partners and investors.