If you are looking for a professional opportunity within the financial modeling field, you have to prepare to leave the interview successfully.

Every interview is different in financial analyst positions. In this article we are going to give you the most common questions that interviewers usually ask in hiring processes:

What do you understand by financial modeling? Why is it useful?

  • How to build a financial model?
  • What is the difference between GM, EBITDA, EBIT, EBT and NP?
  • What is Working Capital and how to interpret it?
  • What are the main characteristics that define a good model?

Make sure you know the following financial ratios:

  • What is sensitivity analysis in financial modeling?
  • What is a circular reference and how to work with it?
  • Tips

1. What do you understand by financial modeling? Why is it useful?

Financial modeling is a quantitative analysis that allows us to make projections and helps us make decisions about a business. It is normally used in asset valuation models or corporate finance.

In investment banking and financial research, financial modeling consists of projecting the financial statements of a company. It is done using historical data and realistic hypotheses, to perform financial analysis and value the company.

We can give an example of this utility: imagine that a company is working on two projects and you want to know if it is better to continue working on both or to concentrate all your efforts on just one. Thanks to financial modeling and through the analysis of various hypothetical factors such as return, risk, cash flows, cost of debt, or other key factors, we obtain projections that will help us make the most appropriate option for the business.

On the other hand, financial modeling is not only reduced to the financial analysis of the company but can also be applied in any area of the company.

2. How to build a financial model?

Financial modeling is as easy as it is difficult. If we find an already complete financial model it may seem somewhat complex, however, it is simply a sum of modules that we must define before starting to be able to build an ordered model.

The main blocks that we are going to find in any financial model are the Profit Loss Account, the Balance Sheet, and the Cash Flows.

Additionally, depending on the type of business, it may be important to separately model other concepts such as Working Capital, amortization, or debt.

Once each concept has been modeled, we will link it with the financial statements it affects (P&L, BS, CF) so that our model is integrated.

3. What is the difference between GM, EBITDA, EBIT, EBT and NP?

  • Gross Margin (GM): or gross margin, it is the difference between the income from sales and the direct costs of said sales.
  • EBITDA: from the gross margin we will subtract indirect costs, such as opex, rent, supplies, etc.
  • EBIT: the difference concerning the previous point is that in this case, we will also add the amortization and depreciation costs of the assets.
  • EBT: starting from EBIT we will add the financial income and expenses of the company to obtain the Pre-Tax Profits.
  • Net Profit (NP): once the taxes have been paid, we will obtain the Net Profit, which we can decide whether to distribute as dividends or keep in the company as reserves.

4. What is Working Capital and how to interpret it?

This is a basic finance question that should be included in the financial modeling interview.

Working Capital is a metric that shows the liquidity of a company in the short term. Represents the part of current assets that are financed by non-current liabilities. It can vary according to the time of year and due to the seasonality of the business, it is very important to have it under control to guarantee short-term liquidity.

It is calculated using the differences between current assets and current liabilities, including the following accounts:

(+) Cash (+) Accounts Receivable (+) Inventory (-) Accounts Payable

How to interpret the Working Capital? Once calculated, we can find 3 different situations:

  1. WC> 0: the company can meet its short-term obligations.
  2. WC = 0: the company could have problems if the payment of a client is delayed.
  3. WC <0: This could lead to a suspension of payments, as the company is not able to meet its short-term obligations.

Knowing which are the 3 situations that we may encounter, we see how the best option will be to have a positive Working Capital, but we must ensure that it is not excessive, since this would imply an opportunity cost because the company would have resources without investing that could be profitable by financing other investments.

5. What are the main characteristics that define a good model?

  • Structured: the main characteristic that defines a good financial model is its structure. If we are not clear on how to order our model, we cannot start working, since we can end up working with a large amount of data that makes it difficult to understand how the model has been built and does not allow changes to the model. For example, we should have 1 or 2 tabs with all the inputs, another with the main financial statements (P&L, BS, and CF), another with financing and returns, but it may vary according to business needs.
  • Flexible: a good financial model must be flexible and allow changes to be made in the future in an agile way since we can find new business opportunities that require prior analysis.
  • Transparent: if we have respected the two previous points, this will be almost complete. All the numbers that appear in the financial model must be obtained from formulas that are linked to other cells, except the inputs, to facilitate that anyone, whether they are a financial analyst or not, can easily understand where each result is obtained.
  • Logical: when modeling we must take into account the “less is more” premise. We are going to put an example; Normally it is of no use to know the electrical consumption of each of the machines that we have in the factory, so it will be more logical to make a global projection of how the electrical consumption of the entire factory will evolve so as not to complicate the model reaching an excessive level of detail that would not contribute anything.

6. Make sure you know the following financial ratios:

  • Liquidity: working capital ratio, acid test, cash ratio, immediate liquidity ratio, leverage, working capital
  • Margins: Gross margin, Net margin, Operating margin
  • Return: ROA, ROE, ROI, PER
  • Periods of: maturity, supply, production, sale, collection, payment

7. What is sensitivity analysis in financial modeling?

Sensitivity analysis is an Excel tool. This allows you to quickly see what would be the result that would be obtained if we modified two variables of our model. That’s right, it allows us to include as many scenarios as we want for each of the two variables and shows us the results for each of the possible combinations, allowing us to make decisions in an agile way.

8. What is a circular reference and how to work with it?

Circular references occur when a cell is linked to itself directly (A5 = A5 + 30) or indirectly (A5 = B2 + 30 and B2 = A5).

The problem with circular references is that they can create an infinite calculation error (known as indefinite iteration) since the cell references itself it will never finish the calculation. There are two solutions to this:

  • The first is very simple and consists of eliminating that calculation and looking for another way to obtain the result without creating a circular reference.
  • The second option is to keep the circular reference but limit the number of times the calculation will be performed, which by default in Excel will be 100.

9. Tips

It will be an added value in your CV to have a certification in financial modeling.

Finmodex has launched the first financial modeling certification, which consists of a test that assesses the ability to correctly develop a financial model. This certification has a dual objective: to guarantee a standard of financial modeling knowledge for selection processes in the financial industry and to provide a competitive advantage for the professionals who take the test.

The modex certification has been tested in selection processes and some of the most prestigious business schools in Europe, with great acceptance by candidates, companies, and investment funds.

“Executing financial modeling is an important skill and a crucial part of the selection process for the best talent in Private Equity,” says Gail McManus, Head of PER. The leading European specialist in Private Equity recruitment in the UK. “ModexPE has the potential to become a valuable tool in the recruiting landscape.”