How to Answer “How would you build a basic three-statement model?” in Investment Banking Interviews
In investment banking interview prep, few prompts come up as often as: “How would you build a basic three-statement model?” It’s a three-statement model interview question that tests whether you can translate accounting mechanics into a clean, auditable model under time pressure.
A strong answer doesn’t list random line items. It explains an organised build order (Income Statement → Balance Sheet → Cash Flow), the core schedules that “link” the statements, and the checks you use to confirm the financial statements actually tie out—like cash reconciliation and the balance sheet balancing.
What Interviewers Test in Investment Banking Technical Questions
In investment banking technical questions, interviewers use this prompt to assess whether you understand how the financial statements connect, not just what each statement contains. They want to hear the key linkages (D&A, working capital, debt/interest, taxes, capex) and the logic for sequencing the build.
They’re also testing modelling judgement: what to keep simple in a “basic” version, where circularity appears (interest and cash sweeps), and how you’d handle it (either with a plug or iterative calc). For investment banking analyst interview questions, this is a proxy for whether you can produce a workable model that another analyst/associate can follow.
Finally, they’re evaluating communication. A good answer is structured, uses consistent sign conventions, and emphasises auditability (clearly separated inputs, drivers, schedules, and checks)—the same habits you’ll need on live deals.
Three-Statement Model Interview Question: Step-by-Step Framework
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Step 1: Set up structure, historicals, and modelling conventions
I’d start by laying out the three financial statements in a consistent format with clear columns for historical years/quarters and forecast periods. Before forecasting anything, I set conventions: signs (e.g., expenses positive on the Income Statement but cash outflows negative on the Cash Flow), units, dates, and a dedicated assumptions section.
Next I input historical Income Statement and Balance Sheet (and ideally Cash Flow) from filings. If Cash Flow isn’t provided, I can rebuild it later from the Balance Sheet movements and non-cash items—but for interview speed, having all three helps. I also create a checks row early: Balance Sheet “Assets – Liabilities – Equity = 0” each period and a cash reconciliation check.
This setup matters in financial modeling interview prep because most errors come from inconsistent signs, mixing inputs with formulas, or not separating drivers from calculations. A clean skeleton makes the linking steps straightforward and makes it easier to explain in an interview.
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Step 2: Build the operating forecast (Income Statement + key schedules)
For a basic three-statement model, I forecast the Income Statement off a small set of drivers. Revenue is usually a growth rate or volume × price; COGS and operating expenses are margins or % of revenue; and I keep line items limited unless the question asks for detail.
Then I add the two operating schedules that create most linkages: depreciation & amortisation (often a simple % of prior PP&E or based on a capex/depreciation assumption) and working capital (days or % of revenue/COGS for AR, inventory, AP). These schedules drive both the Income Statement (D&A) and the Balance Sheet (net working capital accounts).
I calculate EBITDA → EBIT → EBT → net income, with taxes as an effective tax rate on pre-tax income (or on EBIT if I’m keeping interest simple initially). At this stage I’m careful to keep inputs explicit and avoid circularity until the financing section is defined.
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Step 3: Forecast the Balance Sheet (working capital, PP&E, and equity)
Next I project Balance Sheet line items using the schedules. Current assets and liabilities come from the working capital build (AR, inventory, AP, other current items if included). For PP&E, I use a simple roll-forward: beginning PP&E + capex – depreciation (and add amortisation separately if modelling intangibles).
On the equity side, I link retained earnings: beginning retained earnings + net income – dividends (or assume a payout ratio / set dividends to zero in a “basic” build). Share count is typically held constant unless the question includes buybacks/issuance.
Cash is the item I don’t “forecast” directly in a basic build. Instead, I will solve for cash via the Cash Flow Statement (or use cash as the plug if I’m avoiding a circular debt schedule). The point to communicate in interviews is that the Balance Sheet is a product of operating/financing assumptions, not an independent forecast.
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Step 4: Build the Cash Flow Statement and link everything
I then construct the Cash Flow Statement in the standard sections:
- CFO: start with net income, add back non-cash items (D&A), and adjust for changes in working capital (increase in AR/inventory is a use of cash; increase in AP is a source).
- CFI: capex (and acquisitions/disposals if included).
- CFF: debt draws/repayments, interest paid (if separated), equity issuance/repurchase, and dividends.
The key output is ending cash: beginning cash + net change in cash. That ending cash feeds back to the Balance Sheet cash line. At this point, the statements should “link”: Income Statement drives net income; Balance Sheet movements drive working capital and investing; Cash Flow produces ending cash.
If there’s no detailed financing, I can keep it basic by using a debt or cash plug to make the Balance Sheet balance—then explain that a more complete model replaces the plug with a debt schedule and optional cash sweep.
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Step 5: Add the financing loop (interest, debt schedule) and run sanity checks
To finish a basic but interview-ready three-statement model, I add a simple debt schedule: beginning balance, mandatory amortisation, optional repayments (if using excess cash), and ending balance. Interest expense is usually average debt × interest rate, which can introduce circularity because interest affects net income, which affects cash, which affects debt repayment.
In an interview setting, I’d describe two clean approaches: (1) use an iterative calculation to resolve the circularity, or (2) keep interest based on beginning-of-period debt/cash to avoid a hard circle. Either is acceptable if you explain the trade-off.
Then I run checks: the Balance Sheet balances every period, cash roll-forward matches the Cash Flow, working capital signs make sense, margins are reasonable, capex and depreciation don’t create implausible PP&E trends, and financing flows reconcile (debt changes on Balance Sheet equal debt flows on Cash Flow). This “audit loop” is what turns a spreadsheet into a usable model in investment banking.
Analyst-Level Answer for Financial Modeling Interview Prep
A basic three-statement model links the Income Statement, Balance Sheet, and Cash Flow so that operating and financing assumptions flow through to cash and the balance sheet. In investment banking, I’d build it in a set order and make sure it’s auditable.
First I set up a clean template with historical periods and forecast periods, consistent sign conventions, and a separate assumptions block. I input historical financial statements and add checks early—Balance Sheet balancing each period and a cash reconciliation.
Second I forecast the operating line items on the Income Statement using a small set of drivers: revenue growth or volume × price, margins for COGS and opex, and an effective tax rate. I add the schedules that create most of the linkages—depreciation/amortisation and working capital—because they affect both earnings and the Balance Sheet.
Third I build the Balance Sheet off those schedules: working capital accounts from days or % assumptions, PP&E via a roll-forward (beginning PP&E + capex – depreciation), and equity via retained earnings (beginning retained earnings + net income – dividends).
Fourth I construct the Cash Flow Statement: start from net income, add back non-cash items like D&A, adjust for working capital changes, subtract capex, and include financing flows like debt draws/repayments and dividends. The net change in cash gives ending cash, which links back to the Balance Sheet.
Finally, if I’m making it interview-complete, I add a simple debt and interest schedule and address circularity either with iteration or by using beginning/average balances. I sanity-check that the Balance Sheet balances, cash ties, and the trends and margins are reasonable.
- Lead with purpose and sequencing (IS → BS → CF) before mentioning schedules.
- Name the core linkages: D&A, working capital, capex/PP&E, retained earnings, debt/interest.
- Be explicit that cash is solved from the Cash Flow (or explain a temporary plug).
- Mention circularity and a practical way to handle it—shows real modelling experience.
- Close with audit checks; interviewers listen for “balance sheet balances” and “cash ties.”
Common Pitfalls in Investment Banking Analyst Interview Questions
- Jumping straight into the Cash Flow without explaining the build order and linkages across the financial statements.
- Forecasting cash as an independent line item instead of deriving it from the Cash Flow roll-forward.
- Ignoring circularity in interest and cash sweeps, or pretending it doesn’t matter in a three-statement model interview question.
- Mixing hard-coded inputs into formulas, which makes the model hard to audit and easy to break.
- Getting working capital signs wrong (e.g., treating an increase in AR as a source of cash).
- Forgetting retained earnings (net income less dividends) and then wondering why equity doesn’t tie out.
Follow-Ups You’ll Hear After Explaining the Linkages
Where does circularity typically show up in a three-statement model, and how do you handle it?
Most commonly in interest expense and revolver/cash sweep logic because cash affects debt and debt affects interest. Handle it with iteration or by using beginning/average balances to break the circle in a basic build.
If the Balance Sheet doesn’t balance, what are the first things you check?
Check cash linking (ending cash from CF to BS), retained earnings roll-forward, working capital sign conventions, and whether debt/equity flows reconcile to the Balance Sheet changes.
How do you model depreciation and capex in a simple way?
Use a PP&E roll-forward with capex as % of revenue (or a flat assumption) and depreciation as % of prior PP&E or a fixed useful-life assumption; link depreciation to the Income Statement and PP&E to the Balance Sheet.
How do you model working capital for investment banking interview questions on financial modeling?
Use AR/AP/inventory days (or % of revenue/COGS), compute the implied balances each period, and flow the period-over-period changes through CFO as uses/sources of cash.
What’s an acceptable ‘plug’ in a basic three-statement model?
Often cash is the plug if you’re not modelling detailed financing, or a revolver/debt plug if you want cash to stay at a minimum. Just state the choice clearly and keep it consistent with the story.
Practice Plan to Get Faster and More Accurate
- Practise a 3-minute “step-by-step guide to three-statement modeling” explanation: setup → operating drivers → BS schedules → CF roll-forward → checks.
- Build the model once from a simple set of financial statements, then rebuild it from scratch timed (30–45 minutes) to simulate analyst pressure.
- Create a short checklist you can say out loud: retained earnings link, PP&E roll-forward, working capital signs, cash ties, BS balances.
- Use AceTheRound to drill the same answer across different company types (high-growth vs mature, leveraged vs low-debt) so you can adapt assumptions without losing structure.
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