20 Most Common Finance Questions
This article will help you ace your upcoming finance interview, below are the most common questions that you can expect to be asked by the interviewer.
1. What are the three main financial statements, and why are they important?
Answer:
Income Statement: Shows profitability by detailing revenue, costs, and net income over a specific period.
- Key Metrics: Gross Profit, Operating Income (EBIT), Net Income.
Balance Sheet: A snapshot of a company’s financial position, listing assets, liabilities, and equity at a specific point.
- Formula: Assets = Liabilities + Equity.
Cash Flow Statement: Tracks cash inflows/outflows across operating, investing, and financing activities.
- Provides insight into liquidity and cash generation.
Importance: Together, these statements provide a full picture of a company’s performance, stability, and cash position.
2. What is EBITDA, and why is it important?
Answer:
EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization.
It shows a company’s core operational profitability, excluding non-operational costs (e.g., interest, taxes) and non-cash expenses (e.g., depreciation).
Importance:
- Used in valuation multiples (e.g., EV/EBITDA).
- Helps compare companies with different capital structures.
4. What is the difference between Enterprise Value and Equity Value?
Answer:
- Enterprise Value (EV): Reflects the total value of the company, including all stakeholders.
EV=EquityValue+ Debt+ PreferredStock+ MinorityInterest− Cash
Equity Value: Reflects the value available to equity shareholders.
Equity Value= EV− NetDebt
Example: If a company has $100M in EV, $20M in debt, and $10M in cash, Equity Value = $100M – $20M + $10M = $90M.
5. What is WACC, and why is it used in valuation?
Answer:
WACC (Weighted Average Cost of Capital) reflects a company’s overall cost of raising capital from debt and equity. It’s used as the discount rate in valuation to determine the present value of future cash flows.
Use: Represents the hurdle rate for investment decisions.
6. What is the difference between cash-based and accrual-based accounting?
Answer:
Cash-Based Accounting: Revenue and expenses are recorded only when cash is received or paid.
Accrual-Based Accounting: Revenue and expenses are recorded when they are earned or incurred, regardless of cash flow.
Example:
If a company makes a sale on credit, cash-based accounting won’t recognize it until payment is received, while accrual-based accounting recognizes it immediately as accounts receivable.
7. What is the purpose of a cash flow statement?
Answer:
The cash flow statement tracks cash inflows and outflows, divided into three sections:
Operating Activities: Cash generated from core business operations.
Investing Activities: Cash spent or earned from investments (e.g., CapEx, asset sales).
Financing Activities: Cash flows from issuing/repaying debt or equity.
It ensures a company can meet its financial obligations.
8. What is a bond yield, and how is it calculated?
Answer:
Bond yield is the return an investor earns on a bond.
- Current Yield
Current Yield= Annual Coupon Payment/ Market Price
- Yield to Maturity (YTM): The total return if held to maturity, considering all payments and the difference between purchase price and face value.
9. What is a financial covenant?
Answer:
Financial covenants are clauses in loan agreements that set specific financial performance benchmarks for the borrower, such as:
Positive Covenants: Requirements to meet certain metrics (e.g., maintaining a debt-to-EBITDA ratio).
Negative Covenants: Restrictions on certain actions (e.g., limits on additional borrowing).
10. Explain the difference between operating leverage and financial leverage.
Answer:
Operating Leverage: The extent to which fixed costs are used in a company’s operations. High operating leverage amplifies profit sensitivity to sales changes.
Financial Leverage: The use of debt to finance operations. High financial leverage increases returns but also risk.
11. What is the difference between a forward contract and a futures contract?
Answer:
Forward Contract: Customized agreement between two parties to buy/sell an asset at a specific price on a future date. Traded over-the-counter (OTC).
Futures Contract: Standardized, exchange-traded contract with daily settlement and margin requirements.
12. What is the time value of money (TVM)?
Answer:
TVM is the principle that money today is worth more than the same amount in the future due to earning potential.
Formula for Future Value (FV)= PV(1 + r)^n
13. What is the relationship between bond prices and interest rates?
Answer:
Bond prices and interest rates are inversely related. When interest rates rise, bond prices fall, and vice versa. This happens because existing bonds must compete with newer, higher-yielding bonds.
14. What are the different types of financial risk?
Answer:
- Market Risk: Risk of losses due to market movements.
- Credit Risk: Risk of borrower default.
- Liquidity Risk: Difficulty in selling assets quickly without a price drop.
- Operational Risk: Failures in processes, systems, or policies.
15. What is the Dupont Analysis?
Answer:
A framework to decompose Return on Equity (ROE):
ROE= Net Profit Margin× Asset Turnover× Equity Multiplier
This helps analyze profitability, efficiency, and leverage separately.
16. How do you calculate free cash flow (FCF)?
FCF= EBIT(1−TaxRate)+ Depreciation− CapEx− ΔWorking Capital
17. What is a stock buyback, and why do companies do it?
Answer:
A stock buyback is when a company repurchases its shares from the market, reducing outstanding shares.
Reasons:
- Boost EPS (Earnings Per Share).
- Signal confidence in the business.
- Return value to shareholders.
18. What is a zero-coupon bond?
Answer:
A bond that does not pay periodic interest. It is sold at a discount to face value and pays the full face value at maturity.
19. What is the difference between a merger and an acquisition?
Answer:
Merger: Two companies combine to form a new entity (e.g., DaimlerChrysler).
Acquisition: One company purchases another and assumes control (e.g., Facebook acquiring Instagram).
20. What is the difference between IRR and NPV?
Answer:
NPV (Net Present Value): Value today of future cash flows minus initial investment.
IRR (Internal Rate of Return): The discount rate where NPV = 0.
Use: NPV shows absolute value; IRR shows percentage return.
Wishing you all the very best for your interview, you have done a great job!😉
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