Financial Modeling Test – Questions & Answers
We have compiled a list of top 20 frequently asked questions in financial modeling that you must know if you are planning a career in this field. This test will help you acquire a basic understanding of what financial modeling is all about, and you can use this understanding for presenting yourself in interviews as well.
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.
Question #1 – What Do You Mean by Financing Modeling?
Answer: Financial modeling means building tools based on Excel spreadsheets to help a business forecasts its future performance as well as earnings based on specific forecasting theories. This allows the management in taking important financial decisions for the company.
Question #2 – What Are the Steps Involved in Financial Modeling?
Answer: You can follow the steps below to create a financial model –
- Gather historical financial information for the last three to five years.
- Analyse the historical information and assumptions for the forecasting of 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, carry out audit and stress testing to check the efficiency of the model.
Question #3 – Give Any Four Examples of Financial Modeling?
Answer: Three statement model, discounted cash flow model, merger model, and budgeting & forecasting model are a few examples of financial modeling.
Question #4 – What Are Some Uses 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
Question #5 – What Is Meant by Working Capital and How Can It Be Forecasted?
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.
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Working capital = Current assets – Current liabilities
Question #6 – Which Are the Three Main Components of Financial Statements?
Answer: The balance sheet, income statement, and cash flow statement represent the three main components of financial statements.
Question #7 – What Does the Balance Sheet, Income Statement, and Cash Flow of Any Entity Indicate?
Answer:
- Balance Sheet: It represents the financial position of a business entity as on a particular point of time by reflecting the values of assets, liabilities, and equity.
- Income Statement: It indicates the financial results achieved by a business in a particular period through its business activities. The net profits are indicated by reducing the value of expenses from incomes.
- Cash Flow Statement: It provides information regarding the sources and application of funds through operating, investing, and financing activities.
Question #8 – What Is DCF Analysis?
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.
Question #9 – What Is Meant by Sensitivity Analysis?
Answer: Sensitivity analysis is a tool of financial modeling that helps an analyst to 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 as a result of an increase in the rates of direct material.
Question #10 – What Do You Mean by Financial Forecasting?
Answer: Financial Forecasting refers to the identification of estimated future performance of a business based on historical data available regarding the business.
Question #11 – How Can Revenues Be Forecasted?
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.
Question #12 – What Are Some Ways to Forecast Costs and Expenses?
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 based on sales, fixed cost based on historical trends and depreciation as a separate item.
Question #13 – From Where Shall the Historical Data of A Company Be Obtained?
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 be not reliable.
Question #14 – Give a Few Examples of Financial Forecasting Methods.
Answer: Some examples of financial forecasting methods include the straight-line method, moving average method, simple linear regression, and multiple linear regression.
Question #15 – How Financial Modelling and Financial Forecasting Differ?
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 by using different techniques on the historical data of a company’s performances.
Question #16 – List Down the Financial Model Layouts.
Answer: There are two layouts, namely:
- The vertical financial model layout
- The horizontal financial model layout
Question #17 – What are Some Financial Ratios that are Used in Financial Analysis?
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
Question #18 – What Do You Understand from Net Present Value?
Answer: Net present value refers to the present value of the future net cash outflows, i.e. 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.
Question #19 – What Is the Meaning and Use of 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 or not.
Question #20 – Which Tools can be Used for Auditing the Financial Models in Excel?
Answer:
- Model structure
- Go to special
- Trace precedents & dependents
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