This post will focus on a few changes to keep in mind as you transition from building three statement models with annual periods to three statement models with monthly periods. Download monthly three statement model (work in progress – updates to come).
If you are new to building models, or lack experience with three statement models, we recommend getting started with an annual three statement model before proceeding with this content (please see the Integrated Financial Statement Model video series for an introduction).
In a financial model with annual periods, revenue is projected as a change over the prior period. For this reason some analysts moving to monthly projections attempt to project revenue in a similar fashion. But in most cases, especially for established businesses, growth should be projected on a Year-Over-Year (YOY) basis. A YOY calculation compares each month in the projected period with the same month in the previous year. By way of example, revenue in January of 20X2 should be calculated as (revenue in January 20X1)*(1 + growth rate). This rule is not without exception, but it applies in most cases. If this concept remains unclear, the video that follows provides a simple introduction with visuals.
For an explanation of the formulas used to project expenses on the income statement please see the link that follows: Cost Structure: Fixed, Variable and Semi-Variable.
Working Capital Accounts: Days Used to Calculate DSO, DIO and DPO
For a little more detail on why this is required, let’s revisit the diagram from the Introduction to Financial Statements video series, which gives us a superficial view of how the three financial statements relate to each other.