Financial Modeling Test

We have compiled a list of the top 20 frequently asked questions in financial modeling that you must know if you plan a career in this field. This test will help you acquire a basic understanding of what financial modeling is all about, and you can also use this understanding to present yourself in interviews.

Please have a look at some of the test questions along with their answers that could help you get a deep insight into financial modeling.

Answer: Financial modeling means building tools based on Excel spreadsheets to help a business forecast its future performance and earnings based on specific forecasting theories. This allows the management to make important financial decisions for the company.

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Answer: You can follow the steps below to create a financial model –

• Gather historical financial information for the last three to five years.
• Analyze historical information and assumptions to forecast future results and performance.
• The assumptions made are used to develop the three projected financial statements, namely income statement, balance sheet, and cash flow statement.
• Estimate the net present value of the future cash flows using the discounting technique. After that, do the sensitivity analysis to test the changes on account of key variables.
• Finally, conduct an audit and stress testing to check the model's efficiency.

Answer: Three statement model, discounted cash flow model, merger model, and budgeting & forecasting model are a few examples of financial modeling.

Answer: Financial modeling is useful in the following domains:

• Deciding the source of finance
• Merger and acquisition deals
• Budgeting and forecasting
• Cost-benefit analysis
• Analysing the company’s stock performance

Besides the above common questions, you might have a few more advanced queries. Those have also been covered below. However, if you think you want to explore more to be able to answer all questions, this Financial Modeling and Valuation Course Bundle is for you.

Answer: Working capital refers to the net funds available with a company for its day-to-day business activities; the same is derived after deducting current liabilities from the current assets of the company.

Working capital = Current assets – Current liabilities

Answer: The balance sheet, income statement, and cash flow statement represent the three main components of financial statements.

Answer:

1. Balance Sheet: It represents the financial position of a business entity at a particular point in time by reflecting the values of assets, liabilities, and equity.
2. Income Statement: It indicates the financial results a business achieves through its activities in a particular period. The net profits are indicated by reducing the value of expenses from income.
3. Cash Flow Statement: It provides information regarding the sources and application of funds through operating, investing, and financing activities.

Answer: DCF analysis, also known as discounted cash flow analysis, is a type of valuation method that identifies the value of a business by estimating its future net cash flows and discounting them using an appropriate discount rate to its present value.

Answer: Sensitivity analysis is a tool of financial modeling that helps an analyst determine how the values of certain dependent variables react to the changes in the values of certain independent variables. For example, an analyst may determine how much profits are expected to reduce due to an increase in the rates of direct material.

Answer: Financial Forecasting refers to the identification of the estimated future performance of a business based on historical data available regarding the business.

Answer: There can be different ways to construct a forecasted revenue model. Some of them include:

• Sales growth
• Volume mix
• Change in prices
• Market size and growth
• Capacity utilization
• Product pricing, etc.

Answer: Cost and expenses can be forecasted based on the following factors:

• As a percentage of sales
• All costs except depreciation as a percentage of sales and depreciation as a separate item.
• Variable costs are based on sales, fixed costs based on historical trends, and depreciation as separate items.

Answer: The past financial data of any company shall be taken from reliable sources such as annual reports or regulatory statements filed with SEC. Any other source may not be reliable.

Answer: Some examples of financial forecasting methods include the straight-line method, moving average method, simple linear regression, and multiple linear regression.

Answer: Financial modeling involves developing financial analysis tools to estimate the financial performance of an entity in the future. At the same time, forecasting refers to determining projected cash flows and results using different techniques on the historical data of a company's performance.

Answer: There are two layouts, namely:

• The vertical financial model layout
• The horizontal financial model layout

Answer: The common financial ratios that are used in the financial analysis include:

• Liquidity ratios such as current ratio, quick ratio, etc.
• Return on assets
• Return on equity
• Debt to equity ratio
• Gross profit ratio, net profit ratio
• Turnover ratios like inventory turnover ratio

Answer: Net present value refers to the present value of the future net cash outflows, i.e., the present value of future cash inflows reduced by the value of future cash outflows. The present values are calculated using an appropriate discounting rate such as IRR.

Answer: IRR refers to the discount rate at which the net present value is zero. It helps in making investment-related decisions as to whether a particular project is worth investing in or not.

Answer:

• Model structure
• Go to special
• Trace precedents & dependents