Financial Structure Modeling And Analysis In A Nutshell

In corporate finance, the financial structure is how corporations finance their assets (usually either through debt or equity). For the sake of reverse engineering businesses, we want to look at three critical elements to determine the model used to sustain its assets: cost structure, profitability, and cash flow generation.

Read: Business Analysis: How To Analyze Any Business

How companies think

Understanding the financial structure of an organization can also inform a lot about the collective incentives which push the company to “behave” in a certain way. 

In short, an organization is a scaled entity; it doesn’t “think” as an individual. Instead, it follows simple dynamics driven by specific incentives.

To understand those incentives, my argument is to look at three key elements:

  • Cost structure,
  • Profitability,
  • And cash flows.

In short, from the way an organization “decides” at a collective level how to spend money to finance its long term assets, what part of the business drives profitability, and how it generates cash to sustain its operations, you can get its logic in the marketplace. 

Let’s look at each of them to understand how they can help us understand any organization.

Cost structure

The cost structure is one of the building blocks of a business model. It represents how companies spend most of their resources to keep generating demand for their products and services. The cost structure together with revenue streams, help assess the operational scalability of an organization.

The cost structure informs the way a company decides to spend its money, and how those financial resources are used to sustain its core asset.

For instance, when it comes to Google, a good chunk of ongoing expenses are spent to keep its search platform running.

The traffic acquisition cost represents the expenses incurred by an internet company, like Google, to gain qualified traffic – on its pages – for monetization. Over the years Google has been able to reduce its traffic acquisition costs and in any case to keep it stable. In 2021 Google spent 21.75% of its total advertising revenues (over $45.56 billion) to guarantee its traffic on several desktop and mobile devices across the web.

Looking at the cost structure doesn’t mean only to look at what’s generating revenues right now. It’s also important to look at those costs that help a company renew its business model.

For instance, Google’s Alphabet spends substantial resources to keep its other bets running

In short, we want to have use a counterbalanced approach:

  • Look at the costs that are financing the core assets that fuel the current business model.
  • Look at the costs that are financing future core assets that will trigger a new business model.


Netflix is a profitable company, which net profits were $5.1 billion in 2021. Growing from $2.7 billion in 2020. The company runs a negative cash flow business model, where it anticipates the costs of content development and licensing through the platform. Those costs get amortized over the years, as subscribers stick to the platform.

Profitability is the ability of a company to generate more income than it spends. As simple as that. For instance, in the graph above you can appreciate how Netflix is a profitable company, its income far exceeds its expenses (we’ll see in the next paragraph why we need to counterbalance profitability with cash generation).

Profitability informs where a company generates most of its income. Usually, the higher margin part of the business is also the most interesting. For instance, Google generates most of its money from its ad network. While its network members’ side is way less profitable.

Google (now Alphabet) primarily makes money through advertising. The Google search engine, while free, is monetized with paid advertising. In 2021 Google’s advertising generated over $209 billion (beyond Google Search, this comprises YouTube Ads and the Network Members Sites) compared to $257 billion in net sales. Advertising represented over 81% of net sales, followed by Google Cloud ($19 billion) and Google’s other revenue streams (Google Play, Pixel phones, and YouTube Premium).

Google tough has to keep its less profitable side of the business because it works as an amplifier for its core profit generation center. Therefore, profitability needs to be assessed from several perspectives:

  • Usually, the higher-margin side will be also the most important. Think of how Google ad network is also the core cash machine.
  • Other with lower margin sides might be used to push the core asset of the organization.

There are a few exceptions to this rule. One example is Amazon, in that case, to really understand the company you need to look at a third element: cash flow generation.

Cash flow generation

Free cash flow is the cash a company generates through its operations, once you take off the non-cash expenses, changes in working capital and capital expenditures. Thus this is the cash “free” to distribution that a company can potentially invest back into the growth of the business.

When you look at the core business model of Amazon (e-commerce platform) you can appreciate how it runs at very tight profit margins.

As of 2021, Amazon has much wider overall profit margins but this is primarily thanks to Amazon AWS, Amazon Prime, and other services that run at a higher marginality.

Instead, while Amazon’s core e-commerce platform ran at tight margins over the years, in reality, it generated a substantial amount of cash flows, which made it possible to fuel and finance the growth of the business.


Therefore, looking at cash flows help us have a more balanced view of the overall business.

As an opposite example, Netflix runs at wider profit margins, it also runs negative cash flows due to its operating model, where the company anticipates cash to produce shows which will be available on the platform to sustain its subscription revenue model, and it will be repaid over the years.

Key takeaways

  • The cost structure can help us understand how companies spend money to keep fueling the growth of their core assets. At the same time, it’s also important to look at those costs that are not generating revenue but might help a company build the next core asset.
  • Profitability helps assess what part of the business generates more income, thus, it’s also the most important piece of the business. In some cases, organizations keep less profitable units, if those help fuel the core part of the business.
  • Profitability needs to be balanced with the cash flow generation. Indeed, a company like Amazon generates tight margins on its e-commerce platform, but that is balanced by the fact, the same business unit also generates abundant cash to finance the aggressive growth of the business.

By looking at those three aspects it is possible to understand the financial model of any organization.

Connected Business Concepts

Financial Structure

In corporate finance, the financial structure is how corporations finance their assets (usually either through debt or equity). For the sake of reverse engineering businesses, we want to look at three critical elements to determine the model used to sustain its assets: cost structure, profitability, and cash flow generation.

CAPM Model

In finance, the capital asset pricing model (or CAPM) is a model or framework that helps theoretically assess the rate of return required for an asset to build a diversified portfolio able to give satisfactory returns.

Capital Structure

The capital structure shows how an organization financed its operations. Following the balance sheet structure, usually, assets of an organization can be built either by using equity or liability. Equity usually comprises endowment from shareholders and profit reserves. Where instead, liabilities can comprise either current (short-term debt) or non-current (long-term obligations).

Financial Modeling

Financial modeling involves the analysis of accounting, finance, and business data to predict future financial performance. Financial modeling is often used in valuation, which consists of estimating the value in dollar terms of a company based on several parameters. Some of the most common financial models comprise discounted cash flows, the M&A model, and the CCA model.

Behavioral Finance

Behavioral finance or economics focuses on understanding how individuals make decisions and how those decisions are affected by psychological factors, such as biases, and how those can affect the collective. Behavioral finance is an expansion of classic finance and economics that assumed that people always rational choices based on optimizing their outcome, void of context.

Value Investing

Value investing is an investment philosophy that looks at companies’ fundamentals, to discover those companies whose intrinsic value is higher than what the market is currently pricing, in short value investing tries to evaluate a business by starting by its fundamentals.

Balanced Scorecard

First proposed by accounting academic Robert Kaplan, the balanced scorecard is a management system that allows an organization to focus on big-picture strategic goals. The four perspectives of the balanced scorecard include financial, customer, business process, and organizational capacity. From there, according to the balanced scorecard, it’s possible to have a holistic view of the business.

Buffet Indicator

The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.

Double Entry Accounting

Double-entry accounting is the foundation of modern financial accounting. It’s based on the accounting equation, where assets equal liabilities plus equity. That is the fundamental unit to build financial statements (balance sheet, income statement, and cash flow statement). The basic concept of double entry is that a single transaction, to be recorded, will hit two accounts.

Income Statement

The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).

Financial Statements

Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory to companies for tax purposes. They are also used by managers to assess the performance of the business.

Revenue Modeling

Revenue modeling is a process of incorporating a sustainable financial model for revenue generation within a business model design. Revenue modeling can help to understand what options make more sense in creating a digital business from scratch; alternatively, it can help in analyzing existing digital businesses and reverse engineer them.

Financial Accounting

Financial accounting is a subdiscipline within accounting that helps organizations provide reporting related to three critical areas of a business: its assets and liabilities (balance sheet), its revenues and expenses (income statement), and its cash flows (cash flow statement). Together those areas can be used for internal and external purposes.

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