Financial Modeling Interview Questions

Financial modeling questions are one of the most important parts of an investment banking interview. To effectively answer modeling questions, participants need a good understanding of fundamental financial modeling concepts and practices.

What is Financial Modeling?

Financial modeling is a type of quantitative analysis commonly used in corporate finance, investment banking, and portfolio management to forecast the financial performance of a company. Financial models are typically built in Microsoft Excel or specialized financial modeling software and involve constructing multiple sheets that contain historical data and future projections.

Application of Financial Modeling 

Financial modeling is a fundamental tool in business and finance and are used in several key ways: 

Valuing a Business for an M&A Transaction 

Financial models, like those using Discounted Cash Flow (DCF) analysis, are used to assess business value within the context of M&A transactions. 

Calculating the Maximum Purchase Price in an LBO Transaction 

Financial models should incorporate a target company’s cash flows, cost reductions, debt structure, and repayment plans. Models help investors make informed bidding decisions, by helping them to understand break-even points and the effect of leverage on returns. 

Calculating the Intrinsic Share Price for Equity Research Report 

Financial models are used to calculate the intrinsic share price by analyzing a company’s financial statements, growth prospects, and market conditions. Equity analysts use models to determine if a stock is undervalued or overvalued. 

Making Capital Budgeting and Forecasting Decisions 

Financial models are used to evaluate potential investments and forecast performance. By analyzing projected cash flows, costs, and returns, financial models help companies make informed capital budgeting decisions, allowing for optimal resource allocation and maximizing profits.  

Capital Restructuring Decisions 

Financial models help to make capital restructuring decisions. Companies can use financial models to evaluate the impact of changes in the capital structure on their financial health. Models can be used to analyze various scenarios to determine the best approach for enhancing shareholder value, like issuing new equity, refinancing debt, or altering dividend policies. 

Other Business Restructuring Decisions 

Financial models are crucial for business restructuring decisions, like selling a specific segment of the business. Models help companies make strategic decisions that improve operational efficiency and align with overall business goals. 

Quick Guide to forecast Income Statement and Balance Sheet 

Forecasting – Income Statement 

Forecasting sales is an important element of the income statement for most companies. Sales are the primary driver for estimating costs, as most costs are variable and dependent on sales. Although across different industries the method for forecasting sales varies, a general rule is to predict both volume and price. These can be forecasted as follows: 

1. Volume is impacted by historic growth, overall industry growth, and market share growth. It is also affected by new product launches and access to new markets. 
2. Price is affected by general market inflation, the company’s ability to pass higher costs to consumers, and industry competitiveness to support the targeted sales volume. 

It is advisable to incorporate these factors across different business segments before modeling the overall sales. 

For more detailed information on forecasting various costs, refer to the download section. 

Forecasting – Balance Sheet 

When forecasting the balance sheet, identify accounts driven by the following activities: 

1. Operational activities: Accounts driven by day-to-day business activity. 
2. Investing activities: Accounts driven by management’s investing decisions. 
3. Financing activities: Accounts driven by management’s financing decisions. 

For more detailed information on forecasting different line items of the balance sheet, please refer to the download section.  

80 Financial Modeling Interview Questions 

Income Statement Interview Questions 

1. How would you estimate revenue for the next few years? 
2. Pick an industry of your choice and explain the levers you would consider. 
3. How will you determine those revenue growth rates? 
4. How would you build different scenarios for revenue? 
5. Would you assess different risks associated with different scenarios? How would you incorporate those in your model? 
6. For how many years would you project revenue? Is a five-year timeline sufficient? 
7. Which reports would you consider for revenue projection? Where can you find those reports? 
8. How would you project COGS?  
9. Is COGS relevant for every industry? 
10. How do you calculate gross margin? Would you assume it to be constant, increasing, or decreasing, and why? 
11. Can increasing gross margins attract more competition? Would you factor that competition into your revenue estimates? 
12. What is SG&A? What kind of expenditure is included in it? 
13. How does scale impact SG&A margins? 
14. Is depreciation a part of SG&A? 
15. How would you estimate depreciation?  
16. How is depreciation different from other expenses? 
17. What is the role of capex in projecting depreciation? 
18. What is a non-recurring expense? How do you model it? 
19. How would you project interest expense? What is the starting point? 
20. Would principal payments impact the income statement? 
21. Why is interest expense the last thing calculated in the model? 
22. How would you determine the interest rate? 
23. What is LIBOR? 
24. Which tax rate would you choose and why? 
25. What is terminal value? How would you calculate it? 
26. What is a terminal multiple? 
27. For benchmarking, how would you identify a peer set? Which levers would you benchmark? 

Balance Sheet Interview Questions 

1. What are cash and cash equivalents (CCE)?  
2. What is the difference between CCE and marketable securities? 
3. How do you estimate cash & cash equivalents? 
4. What is operating cash? Is it the same as CCE? 
5. How would you project inventory?  
6. Is inventory relevant for every industry? 
7. How would you project accounts receivable and accounts payable? How does scale impact these two? 
8. What is operating working capital (OWC)?  
9. Why would some companies within the same industry have negative OWC while others have positive OWC?  
10. Why is negative OWC preferred? 
11. How would you project Plant Property & Equipment (PPE)? What are the key levers to consider?  
12. How does PPE impact cost and revenue estimates? 
13. How would you fund the projected capex? Which levers should you consider to determine the optimal sources of funds? 
14. How would you calculate the maximum debt level? 
15. Considering the pros and cons of debt versus equity financing, what factors would you weigh to determine the best approach for raising capital? 
16. How do you prepare a debt payment schedule? How does it impact the firm’s credit rating? 
17. Which line items of the Income Statement have a direct impact on the Balance Sheet? Which ones have an indirect impact? 
18. How does dividend payment affect the Income Statement, Balance Sheet, and Cash Flow Statement? 
19. What is a circular reference?  
20. Provide examples of circular references in financial modeling. 
21. What is excess cash? How do you calculate it? 
22. What is a revolver? How do you calculate the revolver amount?  

Cash Flow Statement Interview Questions 

1. What is the objective of creating a Cash Flow Statement (CFS)? 
2. What are the three key line items of the CFS? 
3. How is the CFS different from the cash account? 
4. What are the two most common methods to calculate cash generated from operating activities (CFO)? 
5. Why does an increase in current assets have a negative impact on CFO while an increase in current liabilities has a positive impact? 
6. Is it possible for a company to generate consistent profits year after year but struggle to pay employee salaries and meet other operating expenses? How would you identify the issue by looking at the CFS? 

Financial Ratios Interview Questions 

1. What are the key liquidity ratios? 

1. Is lower the better in case of liquidity ratios? How does this differ for asset-heavy versus asset-light industries? 
2. What are the key asset management ratio? 

1. What are the key industry-specific nuances in asset management ratios? How would these ratios differ for a manufacturer versus a retailer within the same industry? 
2. How does a high inventory turnover ratio impact return on equity and return on total assets? 
3. What is the key debt management ratio? 

1. Would you prefer a high ROE or a high net income margin? 
2. If a company wants to improve its ROA, what strategic decisions can it make based on an analysis of its current financial ratios? 
3. How can financial ratios be used to assess a company’s risk profile for potential investors or lenders? 
4. Can financial ratios be used to predict future performance or upcoming trends for a company or industry? 

Excel Formulas Interview Questions 

1. Beyond basic scenario analysis, explain how you would use two-variable data tables to analyze the combined impact of changes in two variables on a financial model’s output. 
2. Given a financial model with multiple variables, explain how you would use Goal Seek to find the input value needed to achieve a desired outcome. 
3. Describe a scenario where you would use Solver in Excel to optimize a financial model. 
4. How would you use VLOOKUP or INDEX/MATCH to find specific data points based on certain criteria?  
5. Explain the advantages and disadvantages of VLOOKUP, INDEX, and MATCH. 
6. How would you handle missing data points or inconsistencies in a dataset before using it for financial modeling? 
7. You need to summarize complex financial data. How would you use data pivots and charts in Excel to create informative visuals for presentations or reports? 
8. How would you ensure your financial model is free of errors? 

Beyond learning and reciting the formulas, be prepared to discuss how you approach building efficient and well-structured financial models in Excel. 

Key Terminologies for Financial Modeling Interview Questions 

1. What is NPV? What is XNPV? 
2. What is IRR? What is XIRR? 
3. What are mid-year adjustments? 
4. What is FCF to firm (FCFF)? 
5. What is FCF to equity (FCFE)? 
6. How do you derive FCFE from FCFF? 

Conclusion 

As you prepare for your investment banking analyst interview, focus on building a strong foundation in financial modeling. Practice extensively with sample models, familiarize yourself with industry-specific nuances, and refine your ability to use Excel for financial analysis This will not only help you answer interview questions confidently but also prepare you for your future role. Financial modeling is a critical skill in investment banking, and with dedication and practice, you can master it and achieve success in your career.