Usually people, who are new to the concept of financial models, have a misconception that there is only one type of financial model which is a three statement model (including Statement of Profit & Loss, Balance Sheet, Cash Flow Statement). 

However, there are various types of financial models and they are used for different purposes. We will be discussing about these models in this article.

Types of Financial Models

1. Three Statement Model
2. Credit Rating Model
3. Discounted Cash Flow (DCF) Model
4. Comparable Analysis Model
5. Merger Model
6. Leveraged Buyout (LBO) Model
7. Model with Scenarios

Three Statement Model

This is the very basic kind of model which only includes three financial statements (Statement of Profit & Loss, Balance Sheet and Cash Flow Statement), as suggested by the name. It requires one to make certain assumptions and only work on the future projections of these 3 statements. There are subsequent schedules which are required to be prepared which will support the statements including:

1. Depreciation Schedule
2. Fixed Assets Schedule
3. Working Capital Schedule
4. Debt Schedule 
5. Tax Schedule etc.

Credit Rating Model

Credit rating Model is usually prepared by the Banks, NBFCs or other Financial Institutions for the purpose of assessing credit worthiness of the borrower. It is only prepared for the purpose of extending debt funding to the borrower. 

It involves working on various ratios including liquidity (like DSCR), Profitability (Interest Coverage Ratio, Profit Margins), Solvency (Debt Equity Ratio, Total Liabilities to Equity Ratio etc.) Credit Rating Model stresses upon the structure of interest payments and principal repayments by the borrower in a timely manner. 

Discounted Cash Flow (DCF) Model  

DCF Model is another prominent type of model which is prepared by Investment Bankers, Management Consultants, Private Equity or Venture Capital people to conduct valuation through cash flows of the company.

They are two types of valuations- Absolute Valuation and Relative Valuation. Absolute Valuation consists of valuation performed through DCF, Dividend Distribution Method etc. Relative Valuation consists of valuation conducted through Trading and Transaction Comparable. 

Valuation using DCF method is usually prepared in DCF model. It is an addition of three statement model with valuation calculation which is an extension from the forecasted cash flows.

Comparable Analysis Model

Comparable Analysis Model is very similar to DCF Model. It is also a composite of three statement model and the valuation. However, the only difference in Comparable Analysis model is that it is made through comparable analysis valuation or valuation multiples using trading and transaction comparable. 

Trading comparable is performed through assessing the valuation multiples of similar companies listed in the stock exchanges and transaction comparable is performed through evaluating the fund raising or M&A transactions of similar companies happened in the past.

Merger Model

Merger Model, as the name suggests, is prepared specifically in case of merger or acquisition of the target by the acquirer. This is a unique type of model which captures the financials and financial performance of both the companies (Target and the Acquirer) with the adjustments of their synergies.

Typically, there are three steps to prepare a merger model as listed below:

1. Preparing a separate model of the acquirer with future projections
2. Preparing a separate model of the target with future projections
3. Merging both the models into keeping some of the adjustments for the synergies which both the companies will bring to each other’s business.

Leveraged Buyout (LBO) Model

Leverage Buyout is a situation in which the acquirer buys a target company using very small portion of his own capital and a major portion of debt or non-equity source which is raised from the market (Banks, NBFCs, Financial Institutions etc.). Assets of the both the companies usually become the collateral of the loan in this situation. 

The model is built keeping in mind both the situations:

1. Acquisition of the target company
2. Raising loan from the market through collateralizing assets of the companies

Major characteristic of a leveraged buyout model is that it only considers debt or non-equity source (like, mezzanine debt, subordinate debt etc.) as a source of external capital in order to earn highest return from the investment as debt is the cheapest source currently which is available in the market.

Model with Scenarios (Convertible Model)

This is a unique type of model which is prepared by high skilled financial analysts. They link the whole model in such a manner that one can see different projections of different scenarios in just one model. The same model shows different results when one changes the scenarios from the assumption sheet.

Usually model with scenarios are prepared keeping three situations in mind:

1. Optimistic (Management)
2. Actual (Base)
3. Pessimistic (Conservative or Investor) 

If you’re a graduate and aspire to be in any finance jobs, one of the most difficult parts is to crack the interviews as interviewers ask some of the very tricky questions whose answers are slightly difficult to get. It makes fresh graduates worry and they tend to spend a lot of time in understanding the type of questions which interviewers might be asking.

Interviewers test a candidate from various aspects and if they feel that the candidate doesn’t even fit in 1 criteria out of multiple, interviewers tend to reject them. Therefore, candidates should excel in all the criteria if they are targeting to be selected.

And, most importantly here, even after going through the Interview questions, candidates need to understand a lot of other aspects of Interviews – First, Interviewer’s expectation from the Interview and second, the type of interview since questions vary as per the type of Interview.

Here, in this blog, I have listed all the 3 aspects which are very critical for any finance interview; Interviewer’s Expectation, Type of Interviews and Type of Finance Questions. 

Major Finance Questions & Topics asked in a finance interview

Given below is an almost exhaustive list of questions which can be asked in a Finance interview from a fresher:

Questions on Financial Statements:

• Structure of Statement of Profit & Loss Account, Balance Sheet and Cash Flows Statement
• Understanding working capital and calculation of working capital days
• Depreciation and its method of calculation
• Calculation of debentures redemption and maturity
• Understanding Equity structure of a company
• Understanding equity shares, preference shares and convertible equity etc.
• Goodwill and its calculation

Questions on Ratio Analysis:

• Understanding of type of ratios and the how that gives a financial overview of any company
• Meaning of ratios and their formulas – Profitability Ratios, Liquidity Ratios, Solvency Ratios etc.

Questions on Forecasting and Analysis:

• Understanding of Capital Budgeting & Forecasting
• Brief of Analysis- Like DCF Analysis, Sensitivity Analysis, Ratio Analysis etc.
• Understanding costing structure and cost analysis
• Understanding of Profitability metrics of any company
• Operational & Financial Metrics of a company

If you need the complete list of questions which were actually asked from our students in Finance interviews, click the button below.

Understanding the Interviewer’s Expectations:

Read about the Company in detail

It is extremely important for any candidate to read about the company in depth before going for an interview. It helps in understanding the lines of conversation, interviewer will be having and candidate can speak in line with the interviewer. While reading about the company, you’re required to cover the following aspects:

• Website of the company
• Profile of the Founders/ Promoters
• Any latest update/ news on the company

Go through Roles and Responsibilities in depth

Candidates shouldn’t take interviewers lightly and shouldn’t commit a mistake of going for an interview without reading to the roles and responsibilities or Job description provided by the company. 

In most of the interviews, Interviewers ask whether you have gone through the roles and responsibilities and documents shared earlier. Not going through the documents make a substandard impact in front of the interviewer. 

Know Your Interviewer’s Profile

Another key point is to understand the profile and educational background of the interviewer. If you don’t have the details on the interviewer’s background, then you’re required to extract the same from an HR or your recruiting consultant.

It helps in a big way to understand the mindset and background of the interviewer and it also helps in predicting the mode of the interview. 

Understanding Type of Interviews:

Written Test Round

This round of interview is conducted to basically assess the analytical knowledge of a candidate. These tests actually play a pivotal role in cutting the candidates strength to shorter than half. It eliminates candidates based on their IQ and Intellectual skills. Following are the type of questions usually being asked in the test round.

• Questions on Logical Reasoning
• Questions on Data Interpretation
• Psychometric questions
• Finance Questions (questions relating to Statement of Profit & Loss Account, Balance Sheet, Cash Flow Statement and Ratios)

Case Study Round

This round is highly likely if you’re getting into a very high profile of finance. The round consists of live case studies and scenarios which you will be dealing with while on the job. The round gives a fair idea to the interviewer about the Candidate’s thought process and candidate’s problem solving skills.

Usually companies into consulting business or Investment Banking business give case studies to the candidates in order to test them for on the job work. These case studies are majorly based upon the knowledge of Financial Modeling.

Technical Round

It is one of toughest rounds of an interview process. It is usually a face to face interview which can also involve more than 1 interviewer (A department dead, immediate senior etc.) and there can be several rounds on technical interview. 

The round includes judging the candidate’s knowledge of finance. And, sometimes the interviewers ask tough questions on finance. Hence, it is required to grasp all the requisite graduate level knowledge of finance before going to any technical round. I have listed some of the finance topics below which are usually asked in any finance technical interview.

HR Round

This round includes personal interaction with HR of the company and HR tries to understand the personality of the candidate and focuses on the following aspects:

• Personal Questions
• Family Background
• Vision/ aspirations of a candidate
• Resume questions
• Expectations from the job etc. 

We hope that you have got a fair idea about the types of questions that are asked in a typical Finance Interview. All the best!

People have a misconception that Financial Modelling is a very difficult task and it takes a lot of effort to build one. Financial Modelling is often regarded as one of the most difficult exercises in the industry and some people find it nearly impossible to build one financial model.

Here, in this article, I will give you some useful tips which will make your model building exercise much easier. These are some of the easy steps to be adopted while working on a model that will make the exercise more fun. These tips will make any model look professional and will majorly avoid any chances of hassle being faced by the analysts and the investors/ evaluators.

1. Understanding of the Industry and Competitors

Some start working on the model directly post the company’s evaluation without even reading about the Industry. However, it is equally important to get a sense of the industry and doing a competitive company’s analysis in order to make the projections.

One should keep in mind that the projections should not be majorly off from the Industry standards and competitors unless there’s a specific reason to justify the same deviation.

It is always considered a good exercise to gather knowledge of other companies’ financials and ratios before projecting the target. This makes the model more reliable and in line with the Industry.

2. Colour Coding

Make different colour codes for the following to make it easily understandable by the model evaluator:

1. Audited Numbers
2. Assumptions
3. Ratios
4. Forecasting

These colour codes can be in the form of cell background colour, font colour, font size, font type etc. There are two major benefits for colour coding:

1. It makes a model look professional
2. One can easily distinguish the numbers in the abovementioned heads 

3. Make a separate tab for Assumptions

It is required to make a separate tab of assumptions in your model and you’re required to keep it separate from all the numbers. The assumption is the most critical part of the model and it serves as a foundation for the projections taken. Hence, investors want to specifically take a look at the assumptions taken.

4. Discussion with the Management

It is extremely important to get the assumptions validated by the management once. As management is running the business and they understand about the company better than anyone. Analysts can write the numbers on excel but it is in management’s hands to make those numbers real.

Analysts should properly discuss these numbers with management and take their observations into consideration. And, the model should be discussed with the majority of people in the management.

5. Make notes for any business point/ observation

A model can be built on various numbers and various scenarios, it is important to list all the observations and critical points in notes for an investor to understand the assumptions taken. Notes justify the answer for taking x assumption instead of y.

For Example; if a company has decided to source their raw materials from a different vendor which is offering them materials at a lower price. It will reduce the raw materials costing taken in Statement of Profit & Loss by some percentages. Mentioning the same reason in notes will give investor/ evaluator an understanding as to why the reduction in raw material prices is built in the model.

6. Break complicated formulas into pieces

Incorporating complicated formulas in a model makes it difficult for others to understand. To make a model more understandable, you are required to split all the complicated formulas or all the complicated steps into various formulas and steps respectively.

Breaking of steps will be slightly longer than the previous complicated method but it will be easy to operate while you will be working on the model along with making it simpler for others.

It there is any complicated formula used in the model, then it is important to provide its simple breakup in notes with proper examples.

7. Make “Index”, “Summary” and “Charts & Graphs” Tab

The model consists of several tabs and it takes hours to go through each and every model item in detail. Hence, analysts are advised to make a summary and charts tab separately for all the important numbers including Revenue, Gross Profit, EBITDA etc.

It gives a summary of the important values forecasted in the model and one does not have to go through the whole model to understand the business in brief. They can simply take a look at these two tabs in detail.

You can also insert hyperlinks on the index sheet for one to directly reach to the required tab by just clicking on the hyperlink. Also, hide some of the extra working files in your model for clean-up.

8. Audit the Model

Once you complete the model, get it auditing by a couple of people to remove all the unexpected errors. There are two ways of auditing:

1. Do audit yourself- By checking each and every formula inserted and the assumptions are taken.
2. Share with others for audit- It is important to get the model audited by at least 2 people because every other individual will come up with their own points and they will not miss something which you might have missed.

Preparation of financial models requires precision and might take even more than 3 weeks of time to complete one fully.

Do you really think that preparation of financial models is a complex task and only financial analysts can perform that task? Or is it really tough to work on complex and lengthy financial models which are even time consuming? 

Well, if it is performed in a proper sequential manner with proper steps, then the complexity breaks down into pieces and it becomes easier to make a professional model.

In the article below, I’ll give you a detailed step by step approach to prepare Financial Models.

Step 1 : Know your Company

It is extremely important to first study about the company whose financial model is getting prepared. This basic study will serve as the base in preparation of the model.  

You can learn about the company through: 

1. Public sources, 
2. Company’s website
3. Discussion with the management of the Company etc.
4. Published annual reports and analysts’ coverage reports (if the company is listed)
5. Regulatory Authority of respective countries (if the company is unlisted)

For example; If you are looking for a company which is based in India, then refer to the link of MCA (Ministry of Corporate Affairs) Website for extraction of the basic information relating to the company.

Step 2 : Understand the Industry Dynamics

Next step is to read and understand the industry dynamics from industry analyses reports. It is required to first determine the right industry of your company as majority of the companies function as per their industry dynamics. 

For Example; if you are looking at a company which is operating a QSR (Quick Service Restaurant) Chain in India, then you are required to look at consumer industry then dig down into further subsets of the industry.

Step 3 : Start with the Audited Numbers

Once you are ready with your study on the company and the industry, first step is to start with the insertion of audited numbers (Statement of Profit & Loss, Balance Sheet & Cash Flow Statement) in excel sheet in a proper format for the last 3-4 years. 

It is highly recommended to incorporate audited numbers for a minimum tenure of last 3 years as it helps in better consideration of growth projections.

Step : 4 Find the Assumptions

Next thing is calculate the past ratios like Revenue Growth, Expenses to a percentage of Revenue, Gross Profit Margin, EBITDA Margin, Working Capital Days etc.

Based on the calculation, you are required to forecast the same ratios for future years to calculate the forecasted numbers. 

For Example; if your company has grown by a Revenue CAGR (Compounded Annual Growth Rate) of 20% for last 3 years and the Industry is also growing by the same rate for future years, then you can also assume the same growth rate of Revenue for next 2-3 years.

Assumptions need to be created in a separate tab for Revenue, Cost, Balance Sheet items and other numbers.

Step 5 : Forecast the Income Statement

Post finding the right assumptions, you should start calculating all the forecasted numbers of Statement of Profit & Loss (P&L) from top to down till all the expenses except Depreciation, Finance cost (Interest) and Income tax.

Till this stage, you will get the forecasted EBITDA figures on your sheet. 

As a Financial Analyst, if you are having very initial rounds of conversation with the investors for fund raising, then forecasted numbers till EBITDA will suffice and you will engage in detailed conversation with the investors at later stages.

Step 6 : Prepare the Supporting Schedules

Before jumping to working on Balance Sheet (BS) directly, it is important to prepare supporting schedules for Balance Sheet. These schedules may include:

1. Fixed Assets Schedule – To show the bifurcation of fixed assets
2. Depreciation Schedule – To show depreciation calculation on various fixed assets as per the relevant country laws
3. Tax Schedule – To Show bifurcation of current tax and deferred tax
4. Equity Schedule – To show bifurcation of equity and retained earnings and money required for funding
5. Loan Repayment Schedule – To show interest and principal obligation occurring periodically
6. Working Capital Schedule – To show the calculation of Receivables, Payables and Inventory 
7. Schedule for other Balance Sheet Items

Step 7 : Complete Statement of Profit & Loss (P&L) and Balance Sheet

Next is to complete the projection of P&L and Balance Sheet through the referencing of schedules build in earlier step. 

You can complete P&L after linking Depreciation, Finance Cost and Income tax from respective schedules. Similarly.

Balance Sheet can be completed through linking subsequent schedules except linking Cash & Bank Balance (Cash & Bank Balance will be calculated post completion of Cash Flow Statement) 

Step 8 : Complete the Cash Flow Statement:

Cash Flow preparation is the easiest part in overall Financial Modelling exercise.

Once the P&L and Balance Sheet (BS) are ready, it only leaves the task of incorporating formulas and doing the linking with P&L and BS for Cash Flow Completion. 

Cash Flow Statement leaves a balance of Cash and Bank at the end of the year which will get linked with the BS’s Cash Balance and will complete the “Three Statement Financial model”.

Step 9 : Prepare Free Cash Flows

Before reaching to this step, you have already succeeded in preparation of “Three Statement Model” i.e; P&L, BS and Cash Flow Statement. 

Further task is to get into Valuations and Sensitivity Analysis.

For Valuation, you are first required to calculate Free Cash Flows to the Firm and Free Cash Flows to Equity through already calculated numbers from 3 statements

Step 11 : Perform DCF Analysis

Next step is to calculate Cost of Equity through CAPM (Capital Assets Pricing Model) Model using Market Rate of Return, Risk Free Rate and Beta along with calculation of Cost of Debt using Interest Rate and Tax Rate which will be helpful in calculation of Weighted Average Cost of Capital (WACC). 

This WACC will be used as a present value rate for calculation of present value of future projected free cash flows. 

Step 12 : Perform Sensitivity Analysis

Post calculation of present value of free cash flows, it is required to do the scenarios check through Sensitivity Analysis.

In this, you are required to calculate various valuation results through changing your assumptions in Optimistic as well as Pessimistic manner. This helps in drawing better conclusion on the authenticity of the assumptions taken.

Step 13 : Perform Ratio Analysis

Performing of Ratio Analysis is considered as a near to completion step. In this step, you’re required to estimate profitability, solvency and liquidity ratios for investors to take better judgement on the investing decisions.

For Example; In your ratio analysis, you need to calculate ratios like Return on Equity, Return on Capital Employed, Return on Assets to highlight profitability position of the company to investors

Step 14 : Prepare Charts and Graphs

Now, it is the time to do some representational efforts. One way is to make required charts and graphs of the important numbers in your first tab.

As Chart and Graphs help in better interpretation of data, you can use them to show those intrinsic values which you want to highlight to your investor.

Investors usually don’t get that much time to spend on just one model, hence, it is recommended to depict important values in a visually comfortable manner, i.e; through graphs.

Step 15 : Final touch up – (Index, Formatting etc.)

As your model is complete now, the only thing which is left now is to do some minor formatting, insert statements & schedules into table, prepare an index with hyperlink etc. 

You can also skip this part, but this step makes your model to look more professional and more attractive.

Frequently Asked Questions (FAQs)