Financial Modeling interview questions and answers ๐Ÿ‘‡

  1. Financial Modeling Interview Questions

Financial Modeling Interview Questions


How do you forecast revenues?


There are inherent tensions in model building between making your model realistic and keeping it simple and robust. The first-principles approach identifies various methods to model revenues with high degrees of detail and precision. For instance, when forecasting revenue for the retail industry, we can forecast the expansion rate and derive income per square meter.

When forecasting revenue for the telecommunications industry, we can predict the market size and use current market share and competitor analysis. When forecasting revenue for any service industries, we can estimate the headcount and use the income for customer trends.


How to forecast free cash flow?


Free cash flow projection involves projecting capital expenditures for each model year. Again, the degree of uncertainty increases with each additional year in the model.


What is sensitivity analysis?


Sensitivity analysis is a financial modelling tool used to analyse how different values of an independent variable affect a particular dependent variable under a certain set of assumptions. It studies how various sources of uncertainty contribute to the forecast's overall uncertainty by posing 'what if' questions.


What is working capital, and how do you forecast it?


Working Capital refers to a specific subset of balance sheet items and is calculated by subtracting current liabilities from current assets.

Working capital forecasting is based on the overall financial requirements and financial policies of the concern. The basic objective of working capital forecasting is either to measure the cash position of the concern or to exercise control over the liquidity position of the concern. The first-principles approach to forecasting working capital typically involves forecasting individual current assets and current liabilities using various working capital ratios, such as receivable days, inventory days, and payable days


What is the difference between NPV and XNPV?


The XNPV function in Excel uses specific dates that correspond to each cash flow being discounted in the series, whereas the regular NPV function automatically assumes all the time periods are equal. For this reason, the XNPV function is far more precise and should be used instead of the regular NPV function.


What are LOOKUP and VLOOKUP?


The most commonly used LOOKUP functions in Excel are VLOOKUP and HLOOKUP. VLOOKUP allows you to search a data range that is set up vertically. HLOOKUP is the exact same function, but looks up data that has been formatted by rows instead of columns.


Which ratios do you calculate for Financial Modeling?


The most common financial modeling ratios are year-over-year growth rate, gross margin, EBITDA margin.


How do you include Stock Options In Financial Models?


This annual expense is reported on the income statement and under stockholder's equity on the balance sheet. When the options are exercised or expire, the related amounts will be reported in accounts that are part of the stockholder's equity section of the balance sheet.


What is Equity financing?


Equity financing is the process of raising capital through the sale of shares. Companies raise money because they might have a short-term need to pay bills or have a long-term goal and require funds to invest in their growth. By selling shares, a company is effectively selling ownership in their company in return for cash.


What is IRR?


The internal rate of return (IRR) is a metric used in financial analysis to estimate the profitability of potential investments. IRR is a discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis.


What is an Income Statement?


An income statement or profit and loss account is one of the financial statements of a company and shows the company's revenues and expenses during a particular period. It indicates how the revenues are transformed into the net income or net profit.


What is DCF?


Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment based on its expected future cash flows. DCF analysis attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future. This applies to the decisions of investors in companies or securities, such as acquiring a company or buying a stock, and for business owners and managers looking to make capital budgeting or operating expenditures decisions.


What are expense models?


Your expense model captures all of your non staffing-related expenses. To create accurate financial statements, and for tax compliance, you must classify all of your expenses properly.


What is a horizontal financial model?


Horizontal analysis is an approach used to analyze financial statements by comparing specific financial information for a certain accounting period with information from other periods. Analysts use such an approach to analyze historical trends.


What does negative working capital mean?


Negative working capital is when the current liabilities of the company are more than its current assets, which suggests that the company has to pay off a bit more than the short term assets it has for a particular cycle.


When do you capitalize rather than expense a purchase?


To capitalize is to record a cost or expense on the balance sheet for the purposes of delaying full recognition of the expense. In general, capitalizing expenses is beneficial as companies acquiring new assets with long-term lifespans can amortize or depreciate the costs. This process is known as capitalization.


What is the composite cost of capital?


Composite cost of capital is a company's cost to finance its business, determined by and also referred to as "weighted average cost of capital" or WACC. Composite cost of capital is calculated by multiplying the cost of each capital component by its proportional weight.


What is the interest coverage ratio?


The interest coverage ratio is a debt and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expense during a given period.


What are adjustment entries?


Adjusting entries are accounting journal entries made at the end of the accounting period after a trial balance has been prepared. After you make a basic accounting adjusting entry in your journals, they're posted to the general ledger, just like any other accounting entry.


What is the LIBOR rate?


LIBOR is basically a standard interest rate at which global banks lend to one another for short term loans.


What is hedging?


Financial hedging is the action of managing price risk by using a financial derivative (like a future or an option) to offset the price movement of a related physical transaction.


What is preference capital?


Preference shares, more commonly referred to as preferred stock, are shares of a company's stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company enters bankruptcy, preferred stockholders are entitled to be paid from company assets before common stockholders.


What is a deferred tax liability?


A deferred tax liability is a liability recorded on the balance sheet to reflect the reporting of tax expense (on the income statement) which is greater than the corresponding tax payable for a period.


What are debentures?


A debenture is a long-term debt instrument issued by corporations and governments to secure fresh funds or capital. Coupons or interest rates are offered as compensation to the lender.