1. Walk me through the three financial statements.

The Income Statement discloses a company's revenues and expenses, which together yield net
income over a period of time. The Balance Sheet discloses a company's assets, liabilities, and
equity on a specific date. The Cash Flow Statement starts with net income from the Income
Statement; then adjusts for non-cash expenses, non-operating expenses like capital
expenditures, changes in working capital, or debt repayment and issuance to arrive at the
company's closing cash balance.
A cash flow statement tells you how much cash is entering and leaving your business in a given
period. Along with balance sheets and income statements, it’s one of the three most important
financial statements for managing your small business accounting and making sure you have
enough cash to keep operating.

2. How are the three main financial statements connected?

Net income flows from Income Statement into the Cash Flow Statement (CFS) as Cash Flow
from Operations. Dividends subtracted from net income are added to retained earnings from
the prior period's Balance Sheet (BS) to come up with retained earnings as on the date of the
current period's BS. The opening cash balance on the CFS is from the prior period's Balance
Sheet, while the closing cash balance on the CFS is the balance on the current period's Balance
Sheet.

3. What Is The Relationship Between The Income Statement, Balance Sheet, And Cash
Flow Statement?
The revenue line, or “top line,” is the first line of the income statement. After deducting various
expenses, you get at the company’s net income, or “bottom line.” The first line of the cash flow
statement is net income. This is subsequently adjusted for all non-cash expenses to arrive at a
cash change over time. The change in cash will match the cash line item on the balance sheet,
giving you a more in-depth understanding of why that particular balance changes. The balance
sheet is unique because it is a snapshot of account balances at a single point in time rather than
throughout time. The balance sheet and net income are linked.

4. If I had only one statement and wanted to review the overall health of a company,
which statement would I use and why?
I prefer to use the cash flow statement to make a decision on a company, especially if I’m trying
to glean how a company is doing in a moment of trouble or crisis. It’s going to show you actual
liquidity, how the company is using cash, and how it’s generating cash. A balance sheet will only
show you the assets and debt of the company at a point in time, and shareholder’s equity just
shows you what’s been paid into the company and what exists net of assets and liabilities. The
income statement has a lot of information—revenue, cost of goods and services, and other
expenses—but I find the cash flow statement most useful for evaluating a company’s overall
health in the short term.” Whether a company has a healthy cash balance and generates
significant cash flow indicates whether it is probably financially stable, and this is what the CF
Statement would show.

Sample Follow-up Question: Now, assume you can choose to see two of a company's
three financial statements. Which would you choose?
I want to see the Income Statement and the Balance Sheet because one can produce an
accurate expected or illustrative Cash Flow Statement with the information presented in the
Income Statement and Balance Sheet.
The Cash Flow Statement begins with Net Income and then adjusts for non-cash and non-
operating expenses, both of which are available in the Income Statement. We can calculate the
changes in net working capital from information on the Balance Sheet to arrive at the Cash Flow
from Operations.
Capital Cash Expenditures in the investing section of the Cash Flow Statement could be inferred
by taking the year-over-year change in PP&E from the Balance Sheet, plus depreciation
expense, less any cash inflows from the sale of capital assets.
Repayments of Debt in the financing section of the Cash Flow Statement can be inferred using
the year-over-year changes in short-term and long-term debt balances while also adjusting for
any debt capital raised. Similarly, repurchases of equity, dividends paid to equity investors, and
equity capital raised would also be reflected on the Balance Sheet.

5. What is the purpose of the changes in the working capital section of the cash flow
statement?
Due to accrual accounting, certain non-cash items affect the income statement and the balance
sheet, like accounts payable and accounts receivable. Therefore, to reverse the effects of the
non-cash items, we adjust for them in the "Changes in working capital" section.
 Sample Follow-up Question: What does it mean if your change in net working capital
is negative on the cash flow statement? Is negative working capital a bad thing for a
company?
While negative working capital by pure definition (i.e., current liabilities > current assets) may
indicate a solvency issue for a company, or an inability to satisfy its obligations, negative
working capital is not necessarily a bad thing.
Suppose a company is making a concerted effort to stretch out its payment terms with its
vendors as much as possible to preserve its cash position (which is not included in the
calculation of working capital). In that case, this will result in negative working capital (since
Accounts Payable would likely cause an excess of current liabilities over current assets).
The company still has the liquidity to satisfy its obligations, but stretching out the vendor
payment provides the company with the most flexibility.

6. What is the difference between accounts payable and accrued expenses?

They are the same thing. The main difference is that accounts payable is typically a one-time
expense with an invoice (such as the purchase of inventory) while accrued expenses are
recurring (like employee expenses). As a result, both accounts are reflected in working capital
calculations.
7. Give some examples of accounting events that are typically involved in compound
entries.
Bank deductions which are associated with a bank reconciliation
Deduction of expenses related to payroll payments
Sales transaction subject to sales tax

8. Can a company have a negative book value?

Yes, a company could have a negative book Equity Value if the owners are taking out large cash
dividends or if the company has been operating for a long time at a net loss, both of which
reduce shareholders' equity. Negative equity means that the company's current assets are fully
funded by debt.

9. What is WACC, and how do you calculate it?

WACC is the acronym for Weighted Average Cost of Capital. It is used as the discount rate in a
discounted cash flow analysis to calculate the present value of a company's cash flows and
terminal value. It reflects the overall cost of a company raising new capital, which represents
the riskiness of investment in the company.
WACC represents the blended cost (or return on the invested capital) to both debt holders and
equity holders, based on the cost of debt and equity for that specific firm.
The formula below helps you calculate the WACC of a company if you are put on the spot and
asked to calculate it as part of your technical interview:
where,
E = Market value of equity
D = Book value of debt
P = Value of preferred stock
KE= cost of equity (Calculate using CAPM)
KD = cost of debt (Current yield of debt)
KP = cost of preferred stock (Interested rate on preferred stock)
T = Corporate tax rate

10. What is goodwill?

Goodwill is an asset that captures the amount paid for acquiring a company over its fair market
value.

Here is an example: Company A buys Company B for $100 million in cash. Company B has one
asset: a factory with a book value of $75 million, debt of $25 million, and equity of $50 million,
which equals the book value (assets minus liabilities).
 Company A's cash balance declines by $100 million to finance the acquisition (cost of
the acquisition)
 Company A's PP&E increases by $75 million (book value of Company B's factory)
 Company A's debt increases by $25 million (Company B's acquired debt)
 Company A's goodwill increases $50 million (purchase price of Company B minus book
value of equity in Company B)
 In short, Goodwill = Consideration paid - Net fair value of assets acquired
 In this case, it is equal to $50 million ($100 million - $50 million)

11. What is a deferred tax liability, and why might one be created?
Deferred tax liability is a tax expense amount reported on a company's income statement not
paid in cash during that accounting period but expected to be paid in the future. This occurs
when a company pays less taxes to the government than they show as an expense on their
income statement.
This can be caused due to differences in depreciation expense between book reporting (GAAP)
and tax reporting. This will lead to differences in tax expenses reported in the financial
statements and taxes payable to the government.

12. Describe the liabilities items on a balance sheet.

 Revolver: This is a line of credit, which is not fixed in size, but rather has a maximum
limit. A company can borrow and then pay off the debt at any time. Think of it as a
 credit card for companies. A Revolver is typically secured by a company's working capital
assets, such as Accounts Receivable, Inventory, and Prepaid Assets.
 Accounts Payable: This is almost the opposite of Accounts Receivable. The company has
received items but hasn't yet paid for them. It's an IOU to their supplier.
 Deferred Revenue: The company has collected cash from customers for services that will
be delivered over time (think a subscription you pay upfront for an entire year). 
 Accrued Expenses: These expenses are recorded on the income statement but haven't
yet been paid in cash. These are typically recurring expenses like rent, salaries, etc.
 Deferred Tax Liability: The company has paid fewer cash taxes than it owes and will have
to make it up by paying additional taxes to the government in the future.
 Long-Term Debt: Just like a car loan or a mortgage on your house, this is an amount of
debt that matures in more than a year.

13. Describe the equity items on a balance sheet.

 Common Stock and Additional Paid-in Capital: This refers to the market value of the
shares of stock when they were issued by the company, not the market value at the
current time.
 Treasury Stock: This is the total value of shares that the company has repurchased from
investors, at the value they were repurchased, not their current value.
 Retained Earnings: This is the company's cumulative net income minus any dividends
that have been paid to equity investors.

14. What is net working capital?

Net Working Capital = Current Assets – Current Liabilities
 Current assets include items on the Balance Sheet like inventory, accounts
receivable, prepaid expenses, and other short-term assets. Current liabilities include
accounts payable, accrued expenses, deferred revenue, and other short-term liabilities.
 An increase in net working capital is a use of cash. This could be from increasing current
assets like inventory or accounts receivable. For example, if you increase inventory, it is
not (yet) a cost on the Income Statement but is still a use of cash due, which needs to be
accounted for on the CF statement.
 A decrease in net working capital is a source of cash. This could include changes such as
increasing accounts payable or reducing inventory. If you reduce inventory, you are
selling more goods than you are producing, which means you realize a cost on your
 Income Statement. This is why in calculating free cash flow, you subtract an increase in
net working capital. 
 On the other hand, if you are increasing accounts payable, you preserve your liquidity by
taking a little longer to pay your vendors for your raw materials/inputs.
 If net working capital went up, a company must have "used" cash to increase (for
example, by purchasing more inventory than they sold).
Net Working Capital is current assets minus current liabilities. It measures a company's ability
to pay off its short-term liabilities with its short-term assets. A positive number means they
can cover their short-term liabilities with their short-term assets. A negative number indicates
that the company may have trouble paying off its creditors, resulting in bankruptcy if cash
reserves are insufficient.

15. What happens on the income statement if inventory goes up by $10?

Nothing. This is a trick question. The only impact will be on the balance sheet and cash flow
statement.

16. What is working capital?

Working capital is typically defined as current assets less current liabilities. In banking, working
capital is normally defined more narrowly as current assets (excluding cash) less current
liabilities (excluding interest-bearing debt)

17.  What does having negative working capital mean?

Negative working capital is common in some industries, such as grocery retail and the
restaurant business. For a grocery store, customers pay upfront, inventory moves relatively
quickly, but suppliers often give 30 days (or more) credit. This means that the company
receives cash from customers before it needs the cash to pay suppliers. Negative working
capital is a sign of efficiency in businesses with low inventory and accounts receivable. In other
industries, negative working capital may signal a company is facing financial trouble.

18. If cash collected from customers is not yet recorded as revenue, what happens to it?
It usually goes into “Deferred Revenue” on the balance sheet as a liability if the revenue has not
been earned yet.

19.  What’s the difference between deferred revenue and accounts receivable?
Deferred revenue represents cash received from customers for services or goods not yet
provided. Accounts receivable represents cash owing from customers for goods/services
already provided.

20. When do you capitalize rather than expense a purchase?

If the purchase will be used in the business for more than one year, it is capitalized and
depreciated.

21. Under what circumstances does goodwill increase?

When a company buys another business for more than the fair value of its tangible and
intangible assets, goodwill is created.

22. How do you record PP&E and why is this important?

There are essentially four areas to consider when accounting for PP&E on the balance sheet:
initial purchase, depreciation, additions (capital expenditures), and dispositions. In addition to
these four, you may also have to consider revaluation. For many businesses, PP&E is the main
capital asset that generates revenue, profitability, and cash flow.

23. How does an inventory write-down affect the three statements?

On the balance sheet, the asset account of inventory is reduced by the amount of the write-
down, and so is shareholders’ equity. The income statement is hit with an expense in either
COGS or a separate line item for the amount of the write-down, reducing net income. On the
cash flow statement, the write-down is added back to operating cash flows as it’s a non-cash
expense but must not be double-counted in the changes of non-cash working capital.

24. Please explain the Revenue Recognition and Matching principles

The revenue recognition principle dictates the process and timing by which revenue is recorded
and recognized as an item in the financial statements based on certain criteria (e.g., transfer of
ownership). The matching principle dictates that the timing of expenses be matched to the
period in which they are incurred, as opposed to when they are actually paid.

25. If you were CFO of our company, what would keep you up at night?
Step back and give a high-level overview of the company’s current financial position, or
companies in that industry in general. Highlight something on each of the three statements.
Income statement: growth, margins, profitability. Balance sheet: liquidity, capital assets, credit
metrics, liquidity ratios. Cash flow statement: short-term and long-term cash flow profile, any
need to raise money or return capital to shareholders.

26. Walk me through the major line items of an income statement (negative numbers are
shown in parentheses)?
The first line of the Income Statement represents revenues or sales. Next, you subtract the cost
of goods sold, which leaves gross profit. Subtracting operating expenses, depreciation, and
amortization from gross profit gives you operating income. Next, you subtract interest and any
other expenses (or add other income) from operating income to get pre-tax income. Then
subtract tax payments and what's left is net income.

27. Walk me through a DCF

 Project out cash flows for 5 - 10 years depending on the stability of the company
 Discount these cash flows to account for the time value of money
  Determine the terminal value  of the company - assuming that the company does not
stop operating after the projection window
 Discount the terminal value to account for the time value of money
 Sum the discounted values to find an enterprise value
 Subtract Net Debt and divide by diluted shares outstanding  to find an intrinsic share
price

28.  If project A has a higher IRR but lower NPV than project B, which project should we
select? Why?
Select project B with a higher NPV. When it comes to comparing different projects with
similar sizes, NPV should be used. However, if the sizes of the projects are very
different, IRR would make more sense.

29. What is the Capital Assets Pricing Model (CAPM)?

CAPM is used to calculate the required/expected return on equity (ROE) or the cost of
equity of a company. The formula for CAPM is as follows:
Re = Rf + ß (Rm – Rf)
The Capital Assets Pricing Model (referred to as CAPM) calculates the required return on
equity or the cost of equity. The return on equity is equal to the risk-free rate (usually the
yield on a 10-year US government bond) plus the company's beta (a measure that compares
the stock's volatility to the stock market) times the market risk  premium.

30. How would a $10 increase in depreciation in year 4 affect the DCF valuation of a
company?
A $10 increase in depreciation decreases EBIT by $10, therefore reducing EBIT (1-t) by$10 *
(1-t), where t is the tax rate. Assuming a 40% tax rate, it drops EBIT (1-t) by $6, but you must
add back the $10 depreciation in the calculation of Free Cash Flow. Therefore your
FCF increases by $4, and your valuation will increase by the present value of that $4 (the
equation for PV is below).
This increase of $4 corresponds to the savings in tax due to depreciation.

31. If your friend has $100 she wants to invest (nothing left uninvested), would you
recommend them to invest in stocks or options of particular security?
Investing in stocks would be inherently less risky since the investment would still be worth a
positive value if the stock price went down to $50, while the option would be worth $0 in the
worst-case scenario. Another thing to keep in mind is that while stocks can be held forever,
options have a date of expiry, after which it will be useless (especially relevant if the
prediction doesn't materialize within the stipulated expiry)

32. What factors affect the price of an option?

Factors affecting option prices include,
 Current stock price
 Exercise price
 The volatility of the stock
 Time to expiration
 Interest rate
 The dividend rate of the stock.

33. What is Beta?

Beta is a measure of the volatility of an investment compared with the market as a whole.
The market has a beta of one, and hence, investments that are more volatile than the
market have a beta greater than one, while those that are less volatile have a beta less than
one.

34. What does spreading comps mean?

Spreading comps means calculating relevant multiples from comparable companies and
summarizing them for easy analysis and comparison. It can be challenging when a company's
data and financial information must be scoured to conduct the necessary research.

35. What is the significance of reconciliation  in accounting?

Reconciliation is a must when it comes to accounting. One set of records should be
matched/reconciled with another so that records are updated quickly. It also helps verify if
any incorrect entry/amount is posted in the books. Some essential types of reconciliations
are bank reconciliations (bank ledger in our books vis-a-vis bank statement), vendor
reconciliation (vendor ledger in our books vis-a-vis our ledger in vendor’s books), and
intercompany reconciliations, etc. In addition, internal reconciliations should also be done.
These include quantity reconciliation of closing stock, cost of goods sold, reconciliations, etc.

36. Explain the difference between working capital and available cash/bank balance.
Working capital is the day-to-day funds requirement for any business. Cash and bank balance
are a part of any organization’s total working capital availability. However, working capital is
more than just cash and bank balances. Current assets and liabilities also make up for the
business’s working capital.
Let me explain using an example. Let us assume that $ 5000 is receivable from a debtor on 1-
Apr-17, and $ 4000 is also payable to a creditor on the same day. However, your organization
does not have sufficient cash or bank balance to pay off the debtor. Therefore, the simple
solution is to recover the funds from the creditor and pay the same to the debtor. This is
how the day-to-day fund requirement of the company gets managed by maintaining
appropriate working capital, which need not only be balanced in the bank or cash in hand.
The formula to calculate working capital = Current Assets – Current Liabilities; looks fairly
simple, but working capital management practically involves – debt management, inventory
management, revenue collection, short-term investments, and planning payments as per the
networking capital inflow.

37. Since you mentioned that MS Excel would be your best friend, give us three instances
in which Excel will make your life easier
• Various reports can be extracted from the ERP. However, reports are often required in
specific formats, and this may not be possible in the ERP. This is where excel comes into the
picture. Data can be sorted and filtered, redundant data fields can be deleted, and the data
can then be presented in a customized format.

 Excel is also required for linking multiple sets of data. So different reports can be
extracted from the ERP using the VLOOKUP in Excel / hlookup function. They can be
clubbed into one report.
 The use of Excel becomes the most important for doing various reconciliations. These
cannot be done in the ERP. E.g., if I need to do a vendor ledger balance reconciliation, I
will extract the vendor ledger from the ERP in Excel and get a similar Excel from the
vendor for his ledger. All the reconciliations will then have to be done in Excel only.
 Also, most organizations make their financial statements in Excel as they have to adhere
to the specific statutory format, which may not be extracted from the ERP. So again,
Excel acts as a savior in this case.

Brushing up basic Excel will come in handy during the interview. Some of the formulae that one
needs to know are sum, sumproduct, sumif, countif, subtotal, min, max, vlookup, hlookup,
pivot tables, round, etc. So have a look at this.

38. What does the cash flow statement say about the company?
It is very interesting to correlate the cash flow statement and the profit and loss statement of
the company. I am trying to say that high revenue does not mean that the company has a high
availability of cash. If the company has excess liquid cash, it does not mean that the company
has earned a profit.
Cash flow shows how much CASH the company has generated in the given year. It can also
show if the company is in a position to pay for its operations soon. This helps to answer what
investors want to know before investing – will the company be able to pay the
interest/principal/dividends as and when due? Earning profit is one thing, but being able to
generate cash when the company needs to pay its debts is another thing.
The cash flow statement has three segments – Cash Flow from operations, Cash Flow from
investing activities & Cash Flow from financing activities. Operations related to day-to-day
operations help the company earn revenue. Investing activities show the company’s capital
expenditure. Financing activities show activities such as borrowings, shares issues, etc
 39. What is the financial impact of buying a fixed asset?
From the financial statement point of view, the following will be the impact:
 Income Statement – Buying will not directly impact the income statement. However,
you will charge depreciation as an expense to the income statement year on year.
 Balance Sheet – Fixed assets will increase, whereas current assets (cash paid) will
decrease if the payment is made in the same financial year. If the payment is not made
in the same financial year, then there will be an increase in current liabilities instead of a
decrease in current assets.
Also, when depreciation is charged to the income statement, the asset will be reduced yearly.
 Cash flow statement – There will be a cash outflow shown under the cash from
investing activities section of the cash flow statement.

40. Difference between FUND FLOW and CASH FLOW STATEMENT

Cash flow refers to the overall cash generated by the firm in a specific accounting period. It is
calculated as the total of cash from operations, cash flow from financing, and cash flow from
investing activities. In contrast, the fund flow of the company records the movement of the cash
in and out of the company during the specified time.
 The cash flow statement is one of the four important financial statements every investor
should look at. It is prevalent and useful when one wants to know about a company’s
liquidity position.
 On the other hand, the fund flow statement talks about a company’s financial position
in a given period. It talks about sources of funds and the application of funds.
Key Differences Between Cash Flow and Fund Flow
 The cash flow statement is one of the four financial statements every investor looks at
to understand the financial position. The fund flow statement, on the other hand, isn’t a
financial statement.
   The cash flow statement is prepared so that the company’s net cash flow can be
calculated at the end of a particular period. A fund flow statement is prepared to see
the sources and uses of funds during a particular period and how that “change in the
funds” affects the company’s working capital.
 The cash flow statement is created by following a cash basis of accounting. On the other
hand, the fund flow statement is created by following the accrual basis of accounting.
 The cash flow statement is used for cash budgeting. Fund flow statement is used for
capital budgeting.
 The cash flow statement is prepared to see the short-term effect of cash flow. The fund
flow statement is prepared for a long-term purpose.

41. Is Depreciation need to add back in Financial statement?

Depreciation is a type of non-cash expense which reduces the value of buildings, equipment,
cars, machinery and other capital assets over time. Depreciation in a given period is calculated
based on the original asset cost and spread out over the asset’s useful life. Each year, as part of
an asset is used up, that portion is shown as a depreciation expense on the income statement.
Depreciation is added back in cash flow statement because it is a non-cash item, which had
reduced the net income, and thus should be added back.
Cash flow statement provides information about cash health of the organization. Depreciation
is the non-cash item and it has been debited in P&L accounts, since the cash flow statement
starts with the net profit/(loss) amount it need to be credited or add back.
DEPRECIATION ADD-BACK
THE PORTION OF DEPRECIATION EXPENSE THAT IS SHOWN ON THE INCOME STATEMENT IS THE ONLY PORTION OF
DEPRECIATION THAT IS CONSIDERED AN "ADD-BACK." THE AMOUNT VARIES BASED ON THE VALUE OF THE
COMPANY'S ASSETS, THEIR REMAINING LIFE AND THE METHOD OF DEPRECIATION USED. THE CHOSEN
DEPRECIATION METHOD DICTATES WHETHER THE COST OF AN ASSET WILL BE EXPENSED EVENLY ACROSS ITS USEFUL
LIFE, OR HAVE A VALUE THAT DECLINES MORE QUICKLY IN THE EARLIER YEARS.

EBITDA is an acronym for a company's earnings before any interest, taxes, depreciation and
amortization have been factored in. The EBITDA calculation requires depreciation expense to be
added back, since it was subtracted out as an expense in the original earnings calculation. In
other words, interest, taxes, depreciation and amortization are all added back to a company's
net income to arrive at EBITDA. EBITDA is commonly used as a metric to value companies by
applying a multiple to EBITDA. Similar-sized companies in the same industry tend to sell for a
certain similar range of EBITDA multiples.

Free cash flow is a metric used to assess and analyze companies that also uses depreciation as
an add-back. Free cash flow shows a company's ability to pay its debt and dividends, invest in
business growth and buy back its stock. Free cash flow shows how much cash the company has
left after it pays the costs of ongoing operations and invests in new business initiatives. Starting
with net income, depreciation and amortization are added back, then capital spending and the
change in working capital are both removed, to arrive at free cash flow.