# Projecting the 3 Financial Statements: The Balance Sheet (19:03)

In this tutorial, you will learn how to decide which Income Statement line items Balance […]

In this tutorial, you will learn how to decide which Income Statement line items Balance Sheet accounts such as Accounts Receivable, Prepaid Expenses, and Deferred Revenue should be linked to.

You’ll also see an example of how to check your work, how to tell when you’ve linked something incorrectly, and what to do with more “random” line items.

2:23: The Rough Answer to Projecting Balance Sheet Line Items
5:43: Rules of Thumb for Specific Line Items
9:36: Example for Atlassian – Checking Your Work
14:38: How to Handle “Random” Line Items
16:30: Recap and Summary

The Rough Answer to Projecting Balance Sheet Line Items

The rough answer is: “Stop worrying about what each individual item should be linked to, and instead worry about the OVERALL change in working capital as a % of the change in revenue.”

This question represents a case of overlooking the forest for the trees – yes, how you link individual items can make a difference, but it does NOT make a bigger difference than the overall change in working capital.

Remember that all that Balance Sheet items such as Accounts Receivable, Prepaid Expenses, Inventory, and Deferred Revenue really impact is the company’s cash flow – does it spend cash as it grows, or does it earn more cash as a result of growth?

If you understand that bigger picture item, you’ll be well on your way to “getting” this concept.

Rules of Thumb for Specific Line Items

Accounts Receivable: Link it to revenue.

Deferred Revenue: Link it to revenue.

Accounts Payable, Accrued Expenses, and Prepaid Expenses: Link these to COGS, or OpEx, or both, depending on the company.

“Other” Assets or Liabilities: Hold these constant or link them to revenue.

“Random” Items: Find a matching Income Statement item and link them there, or make them a percentage of revenue.

Example for Atlassian – Checking Your Work

For Atlassian, we check all the numbers by calculating the historical Change in Working Capital and then comparing the Change in WC as a % of the Change in Revenue to the future numbers there.

Historically, the average Change in WC as a % of the Change in Revenue was around 23%, and going forward it is set to approximately 10-20%, so we feel it is a reasonable estimate.

If we had linked to an incorrect line item instead, such as linking Trade Payables to Revenue rather than OpEx, it would be fairly noticeable since the Change in WC would not follow a clean trend.

How to Handle “Random” Line Items

For “random items,” such as Maintenance Provisions on a company’s Balance Sheet, you can always try to match them with the relevant Income Statement line items. That works in this example for EasyJet.

If that doesn’t work, you could just set these items to a % of revenue instead and simplify the whole process.

You can check your work with the same method: calculate the Change in WC as a % of the Change in Revenue and verify that it follows a relatively clean trend line over time.

Recap and Summary

Whenever you build 3-statement projections, always start with the END GOAL – measuring the cash flow impact – in mind.

Accounts Receivable and Deferred Revenue: Link it to revenue. Inventory: Link it to COGS. Accounts Payable, Accrued Expenses, and Prepaid Expenses: Link these to COGS, or OpEx, or both, depending on the company.

“Other” Assets or Liabilities: Hold these constant or link them to revenue.

“Random” Items: Find a matching Income Statement item and link them there, or make them a percentage of revenue.

To check your work, determine if the company spends in advance of its growth (the Change in WC as a % of the Change in Revenue will be negative), or whether it gets extra money as a result of its growth (the Change in WC as a % of the Change in Revenue will be positive).