What is a three-way financial model?

What is a three-way financial model?

A three-way financial model is an integrated tool that brings together the three core financial statements: the profit and loss statement (P&L), the balance sheet, and the cash flow forecast. Instead of looking at each report separately, this model shows how they interact with each other.

The benefit of connecting them is that you see not only whether your business is profitable but also whether you have enough cash to pay bills and how your assets and debts change over time. A business can look profitable on a P&L but still run into trouble if cash isn’t coming in when needed. The three-way model stops that blind spot.

I like to compare it to health: diet, exercise, and sleep all matter, but you only understand your wellbeing when you consider all three together.

Breaking down the three components

Profit and loss statement (P&L)

This report tracks your income and expenses over a period of time, usually monthly or annually. It shows whether you’re making a profit or a loss.

The P&L answers questions such as: Am I selling enough? Are my expenses under control? Am I making a profit on paper?

For example, you might see $200,000 in revenue, $150,000 in expenses, and a $50,000 profit. That sounds positive, but it doesn’t show when cash actually arrives in your account. If customers pay late, that profit may not feel very real.

Balance sheet

The balance sheet provides a snapshot of what your business owns and what it owes at a given point in time.

It covers assets such as stock, equipment, and cash in the bank, as well as liabilities like loans, tax owed, and unpaid supplier bills. The balance sheet also shows equity, the residual value left for you as the owner.

The key question it answers is: What is the financial position of my business right now?

Cash flow forecast

Cash flow is the lifeblood of any small business. The forecast shows how cash moves in and out over time. It captures when you actually receive money from customers and when you pay suppliers, wages, or tax.

Cash flow answers: Can I pay my bills on time? Do I have enough to cover staff wages next month? Can I afford to invest in new equipment?

Without a cash flow forecast, you might end up in a situation where you’re profitable on paper but unable to pay rent because invoices are still outstanding.

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Why linking the three matters

Looking at these reports separately gives only fragments of the picture. Linking them together creates a powerful tool for understanding your business.

The P&L might show profit, but until you connect it to the cash flow forecast you won’t know whether you can actually pay your bills. The balance sheet might show a loan, but without the P&L you won’t see whether repayments are sustainable.

By combining the three, you can understand how sales affect your cash, how investments affect your liabilities, and how growth impacts your working capital.

Take the example of a café. On paper, the café might show strong profits. But if most customers pay on account and invoices take 60 days to settle, the café may run short of cash and struggle to pay suppliers. A three-way model would highlight this risk in advance.

How a three-way financial model works in practice

Building a three-way model usually follows a clear process:

1. Start with a P&L forecast. Estimate revenue, expenses, and profit based on realistic assumptions.
2. Link the results to the balance sheet. Profits add to equity, new loans increase liabilities, and asset purchases change the asset base.
3. Feed these changes into the cash flow forecast. This reflects the timing of when you actually receive or pay money.

This creates a loop where decisions in one statement flow into the others. If you extend supplier terms, your cash improves, but liabilities grow on the balance sheet. If you buy new equipment, assets increase, but cash decreases.

Modern accounting software can automate much of this, removing the need for complex spreadsheets. That’s a game-changer for small businesses that don’t have time to build models from scratch.

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Benefits of using a three-way financial model

Better decision making

When you can see the impact of choices across all three statements, your decisions become sharper. For example, you can test what happens to cash if you hire another staff member or increase marketing spend.

Scenario planning

A three-way model lets you prepare for different scenarios. You can model best case, worst case, and most likely case, giving you a plan for unexpected situations. This is especially useful when the economy is uncertain.

Stronger funding applications

Banks and investors often ask for three-way models because they provide a clear view of business viability. Presenting one shows professionalism and a strong grasp of your numbers.

Early warning system

Because the model is connected, it can highlight issues before they become serious. A shortfall in two months’ time is visible today, giving you time to adjust, negotiate with suppliers, or secure finance.

Common mistakes and how to avoid them

I’ve seen many small businesses fall into avoidable traps. The most common include:

• Focusing only on profit without checking cash impact.
• Being overly optimistic in sales forecasts.
• Forgetting to include tax payments in cash flow.
• Treating the model as a one-off exercise rather than updating it regularly.
• Trying to manage it all in manual spreadsheets, which often leads to errors.

The best way to avoid these mistakes is to use tools that automate calculations and keep the model live.

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How to set up a three-way model for your business

If you want to get started, here’s a practical approach:

• Select accounting or financial planning software that supports integrated modelling.
• Gather accurate historical data, including P&L, balance sheet, and cash flow reports.
• Build assumptions for future sales, expenses, debt repayments, and investments.
• Update regularly, ideally monthly or quarterly.
• Involve your accountant if needed, but make sure you understand the numbers personally so you can act quickly.

The process may sound complex at first, but once you have a working model it becomes a powerful tool for daily decision making.

How Thriday makes this easier

Most small business owners don’t have hours to spend updating spreadsheets. That’s why I use Thriday, which automates accounting and links banking, bookkeeping, and tax in one place.

Thriday automatically connects your profit and loss, balance sheet, and cash flow. With the help of Luca, the AI assistant, you can also view your numbers in simple reports. Instead of guessing whether you can afford to hire, you can see the forecast instantly.

This saves time, reduces errors, and provides peace of mind.

Final thoughts

A three-way financial model is more than just an accounting exercise. It’s a survival tool that helps you make better decisions, secure funding, and avoid nasty surprises. Running a business without one is like flying blind.

By linking profit, balance sheet, and cash flow, you can see the full picture and plan with confidence. If you want to save time and stay in control, consider setting up a three-way model through software like Thriday. It could be the smartest financial decision you ever make.