In this article
The three statements
Walk me through the three financial statements.
The income statement shows revenue, costs and profit over a period. The balance sheet shows what the company owns, owes and has left for shareholders at one date. The cash flow statement reports cash coming in and going out. The Securities and Exchange Commission (SEC) guide defines them in just those terms (SEC guide, modified 2007). Net income links the first to the others: the income statement produces net income, the cash flow statement turns net income into cash, and the balance sheet takes ending cash and retained earnings.
Why it is asked: it is the opening question of most finance and banking interviews.
Text description of the diagram
- The income statement produces net income.
- The cash flow statement turns net income into cash.
- The balance sheet takes ending cash and retained earnings.
If depreciation rises by 10, how do the three statements change?
Assume a tax rate of 25%. Pre-tax income falls by 10 and tax falls by 2.5, so net income falls by 7.5. On the cash flow statement you add the 10 back, so operating cash rises by 2.5. On the balance sheet, equipment falls by 10 and cash rises by 2.5, so assets fall by 7.5, matching the 7.5 drop in retained earnings.1
Why it is asked: it proves you understand how the statements connect.
Why can a profitable company run out of cash?
Net income includes items that are not cash yet. Sales on credit raise profit but not cash until the customer pays, inventory ties up cash before it is sold, and spending on equipment is not an expense in the period it is paid. The cash flow statement shows these gaps, which is why lenders watch it as closely as profit.
Why it is asked: it separates profit from liquidity.
What is working capital and what does an increase do to cash?
Working capital is current assets minus current liabilities, such as receivables and inventory less payables. When receivables or inventory rise, cash is tied up and operating cash falls by the same amount; when payables rise, the company is financing itself with suppliers and cash rises. In a model, forecast each item from days of sales, inventory or payables.
Why it is asked: working capital drives the cash line in every forecast.
Valuation
Walk me through a discounted cash flow.
A discounted cash flow values a company as the present value of its future free cash flows. Forecast unlevered free cash flow for five to ten years, add a terminal value for the years after, discount everything at the weighted average cost of capital (WACC), and sum to get enterprise value. Then subtract net debt to reach equity value.
Why it is asked: the discounted cash flow is the standard intrinsic valuation.
What is the weighted average cost of capital (WACC) and how do you calculate it?
The weighted average cost of capital is the blended return that a company's investors require, weighted by how the company is financed. It equals equity weight times cost of equity plus debt weight times the pre-tax cost of debt times one minus the tax rate. With 70% equity at 9.5% and 30% debt at 6%, taxed at 25%, it is 8.0%.1
Why it is asked: it is the discount rate in the valuation.
How do you estimate the cost of equity?
Use the capital asset pricing model (CAPM): risk-free rate plus beta times the equity risk premium. The ten-year Treasury yield was 4.96% on 22 October 2026 (Federal Reserve Economic Data (FRED), 10-year series). With an illustrative beta of 1.1 and premium of 4.5%, the cost of equity is 9.91%.1 For context, Damodaran's table of 5 January 2026 shows an implied US premium of 4.46% (Damodaran, 2026).
Why it is asked: it tests whether you can source each input.
What is terminal value and how do you calculate it?
Terminal value is the value of all cash flows after the explicit forecast period. The common method, the Gordon growth formula, is the last cash flow times one plus growth, divided by the discount rate minus growth. In our example, cash flow of 132 in year 5, growth of 2.5% and a discount rate of 8% give 2,460 at year 5, or 1,674 in today's value.1
Why it is asked: terminal value is usually most of the answer.
Why is terminal value so large, and is that a problem?
In the example it is 78.5% of enterprise value, because the explicit five years are worth only 458 of a total 2,132.1 That is normal for a growing business, but it means the valuation hangs on two inputs, growth and the discount rate. Say you would cross-check with an exit multiple and show a sensitivity table.
Why it is asked: it shows you know where the model is fragile.
Why can growth never be higher than the discount rate?
The Gordon formula divides by discount rate minus growth. As growth approaches the discount rate the denominator shrinks and value explodes: at 8% and growth of 7.5%, terminal value would be 200 times next year's cash flow, against 18.2 times at 2.5%.1 A company cannot outgrow the whole economy forever, so terminal growth is kept at or below long-run economic growth.
Why it is asked: it catches candidates who plug in aggressive growth.
How would you show how sensitive a DCF is?
Build a two-way table of enterprise value across discount rates and growth rates. In the example, at growth of 2.5%, the value is 2,615 at 7%, 2,132 at 8% and 1,799 at 9%, so one point of discount rate moves value by about a fifth.1 Present a range and explain what you believe, not a single number.
Why it is asked: a point estimate hides the uncertainty.
Text description of the diagram
- At a 7% discount rate the illustrative enterprise value is 2,615.
- At 8% it is 2,132 and at 9% it is 1,799.
What is the difference between enterprise value and equity value?
Enterprise value is the value of the whole operating business, to all capital providers. Equity value is what belongs to shareholders. You get from one to the other by subtracting debt and adding cash. With enterprise value of 1,500, debt of 400 and cash of 100, equity value is 1,200.1 Add preferred stock and minority interests to the deductions when they exist.
Why it is asked: mixing the two gives wrong multiples.
Which valuation multiples would you use, and why enterprise value to EBITDA?
Earnings before interest, taxes, depreciation and amortisation (EBITDA) is a profit measure that ignores those four items. Enterprise value to EBITDA ignores capital structure and depreciation policy, so it compares companies that finance and account differently. Use price to earnings for stable, profitable firms, and revenue multiples only where profit is absent. Always choose peers by business model and growth, not only by industry label.
Why it is asked: it tests judgement about comparability.
Knowing it is half the job. Saying it is the other half.
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How does a leveraged buyout work, and how do you measure returns?
In a leveraged buyout (LBO), a buyer pays for a company with a large share of borrowed money, then uses the company's cash flow to repay debt before selling. Returns are measured by the multiple of invested capital (MOIC) and the internal rate of return (IRR), the annual discount rate at which the present value of the cash flows in and out nets to zero. Putting in 400 and getting 1,000 back after five years is 2.5 times and an IRR of 20.1%.1
Why it is asked: it is the core of private equity interviews.
What makes a deal accretive or dilutive?
A deal is accretive if the buyer's earnings per share rise after it and dilutive if they fall. Compare the target's earnings and the financing cost: paying with shares dilutes when the target's price-to-earnings ratio is higher than the buyer's, and paying with debt is accretive when after-tax interest is lower than the target's earnings yield. Add synergies and one-off costs separately.
Why it is asked: merger questions test financing logic.
Building and checking models
How do you forecast revenue?
Build it from drivers, not a growth percentage alone: price times volume, customers times average revenue, or capacity times utilisation. Anchor the first year on recent trends, fade growth over time, and compare the result with the market's size using market sizing. Write each assumption in one input cell, with its source.
Why it is asked: the revenue line drives everything.
What is the difference between unlevered and levered free cash flow?
Unlevered free cash flow is cash available to all investors before interest, so it values the whole firm and is discounted at WACC. Levered free cash flow is cash left after interest and debt repayments, so it belongs to shareholders and is discounted at the cost of equity. Mixing a rate with the wrong cash flow is a common error.
Why it is asked: it checks that you match cash flows to discount rates.
How do you check that a model is correct?
Check that the balance sheet balances in every period, that ending cash on the cash flow statement equals cash on the balance sheet, that signs are consistent, and that totals equal the sum of their parts. Change an input and watch every statement move. Keep inputs, calculations and outputs on separate, labelled sections.
Why it is asked: an unchecked model is a liability.
How do you handle circular references such as interest on average debt?
Interest depends on average debt, and debt depends on cash flow after interest, which creates a circle. Either switch on iterative calculation with a circuit-breaker switch, or avoid the circle by calculating interest on opening debt. Say which you chose and why, because circularity can make a model unstable.
Why it is asked: it tests modelling discipline, not formulas.
Tell me about a model you built and how you presented it.
Use the situation, task, action, result (STAR) structure from the STAR method: the decision the model supported, the assumptions that mattered most, the error you found and fixed, and what the audience did with it. Quote one number that changed a decision. See investment banking interviews for the wider round.
Why it is asked: it shows judgement and communication, not only technique.
How these interviews are run
Modelling rounds range from a verbal walk-through to a timed case on a spreadsheet, often after technical questions about accounting and valuation. Practise saying each answer aloud in under a minute, then do one full model from a company's annual report. Prepare questions to ask the interviewer, and read how interview loops work. Related topics are quantitative finance interviews and finance and admin interviews.
- Net income links the three statements: it feeds cash flow and retained earnings.
- Value is the present value of free cash flow at the weighted average cost of capital.
- Terminal value is most of a DCF, so show a sensitivity table.
- Enterprise value minus net debt is equity value.
- Check the balance sheet and cash tie in every period.
Sources
- Beginners' Guide to Financial Statements — U.S. Securities and Exchange Commission (page modified 2007-02-05, read 2026-10-24), 5 Feb 2007
- Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity (DGS10) — Board of Governors of the Federal Reserve System, via FRED (read 2026-10-24), 22 Oct 2026
- Cost of Equity and Capital (US) — Aswath Damodaran, NYU Stern (January 2026 data, read 2026-10-24), 1 Jan 2026
- Country Default Spreads and Risk Premiums — Aswath Damodaran, NYU Stern (updated 2026-01-05, read 2026-10-24), 5 Jan 2026
