A financial model’s essence is translating business logic into numerical relationships: how revenue drives profit, how profit affects cash flow, and how the balance sheet links to the income statement and cash flow statement. A good financial model has: **Transparent assumptions** (input layer separated from calculation layer; all key assumptions clearly labeled); **Complete logic** (three statements balance, cash is traceable, errors are reproducible); **Easy to use** (scenarios are switchable, sensitivity analysis runs quickly).
## Three-Statement Linkage Logic
**Income Statement (P&L)**: Revenue → minus costs → minus expenses → EBITDA → minus depreciation/amortization → EBIT (operating profit) → minus finance costs → pre-tax profit → minus income tax → net profit. Net income flows into balance sheet retained earnings; depreciation is added back in the cash flow statement’s operating activities.
**Balance Sheet**: Assets = Liabilities + Equity. Working capital items (accounts receivable, inventory, accounts payable) are driven by revenue and costs from the income statement; fixed assets are driven by CapEx and depreciated; debt items are driven by financing assumptions. Balance sheet equilibrium is the key consistency validation (if it doesn’t balance, the model has a logical error).
**Cash Flow Statement**: Operating cash flow (net profit + depreciation – working capital changes) + Investing cash flow (-CapEx) + Financing cash flow (borrowings – repayments – dividends) = period cash change. The cash flow statement is the core tool converting accrual basis (income statement) to cash basis.
## DCF Valuation Introduction
DCF (Discounted Cash Flow) is the most fundamental method for estimating enterprise intrinsic value: project the enterprise’s future Free Cash Flow (FCF) → discount using a discount rate (WACC, Weighted Average Cost of Capital) → add Terminal Value → obtain Enterprise Value (EV). Key formulas: FCF = EBIT×(1-tax rate) + Depreciation – CapEx – Working Capital Increase; WACC = Cost of Equity × Equity Weight + Cost of Debt × (1-tax rate) × Debt Weight.
See [Workplace Data Literacy](https://sunqi.org/data-literacy-workplace-en/) and [CFI Financial Modeling Courses](https://corporatefinanceinstitute.com/resources/excel/financial-modeling/).
