Accounting
Technical Interview
Questions.
Source: WallStreet Prep
Q. Walk me through the income statement.
01
A. The income statement or profit & loss shows a company’s
profitability over a specified period of time by taking its revenue and
subtracting out various expenses to arrive at net income.
Although you can find various style of of reporting in Income
statement among various companies but the base is same.
There is also an income statement prepared for management which
comprises variable and fixed costs.
Standard Income Statement:
Revenue
Less: Cost of Goods Sold (COGS)
= Gross Profit
Less: Sales, General, & Administrative (SG&A)
Less: Research & Development (R&D)
= Earnings Before Interest, Tax, Depr & Amort. (EBITDA)
Less: Depreciation and Amortization
= Earnings Before Interest & Tax (EBIT)
Less: Interest Expense
= Earnings Before Taxes (EBT)
Less: Income Tax
= Profit after Tax (PAT)
Less: Preference Dividend
= Earnings available to equity shareholders (EAES)
Divide: No. of o/s equity shareholders
= Earnings per share (EPS)
Q. Walk me through the balance sheet?
02
A. The balance sheet shows a company’s financial position, The
carrying value of its assets, liabilities, and equity at a specific point in
time.
Company’s assets have to have been funded somehow, assets must
always equal the sum of liabilities and shareholders’ equity.
Assets:
Current Assets: Highly liquid assets that can be converted into cash
within a year, including cash and cash equivalents, marketable
securities, accounts receivable, inventories, and prepaid expenses.
Non-Current Assets: Illiquid assets that would take over a year to
be converted into cash, namely plant, property, & equipment (PP&E),
intangible assets, and goodwill.
Liabilities:
Current Liabilities: Liabilities that become due in a year or less,
including accounts payable, accrued expenses, and short-term debt.
Non-Current Liabilities: Liabilities that won’t become due for over a
year, such as deferred revenue, deferred taxes, long-term debt, and
lease obligations.
Shareholders’ Equity: The capital invested into the business by
owners, consisting of common stock, additional paid-in capital and
preferred stock, as well as treasury stock, retained earnings, and
other comprehensive income (OCI).
Q. Could you give further context on what
assets, liabilities, and equity each represent?
03
A. Assets:
The resources of any company that can have a positive economic
value and that can be exchanged for money or bring positive
monetary or economical benefits in the future.
Basically anything from which you can generate money be it
Machines or Debtors.
Liabilities:
The outside sources of capital that have helped fund the company’s
assets and run the operations.
These represent unsettled financial obligations to other parties
whether short or long.
Equity:
The internal sources of capital that have helped fund the company’s
assets, this represents the capital that has been invested into the
company.
There is no obligation on the company to return them their money
since it’s their company AKA The owners of the company.
Q. Could you explain me briefly about the cash 04
flow statement and its components?
A. The Cash Flow Statement (CFS) summarizes a company’s cash
inflows and outflows over a period of time.
The revenues and expenses that did actually took place (Movement)
in cash form are considered here hence the Cash Flow Statement.
The CFS starts with net income, and then accounts for cash flows
from operations, investing, and financing to arrive at the net change
in cash.
Cash Flow from Operating Activities (CFO):
It tells us cash generated from the core business. Starts from net
income, then non-cash expenses are added back such as D&A and
stock-based compensation, and then changes in net working capital.
Cash Flow from Investing Activities (CFI):
Captures long-term investments made by the company, primarily
capital expenditures (CapEx) as well as any acquisitions or
divestitures and any investment in any security or else.
Cash Flow from Financing Activities (CFF):
Includes the cash impact of raising capital from issuing debt or
equity net of any cash used for the repurchase of shares or the
repayment of debt. Dividends paid to shareholders will also be
recorded as an outflow in this section.
Q. How are the three financial statements
connected?
05
Income Statement (I/S) ↔ Cash Flow Statement (CFS)
Net income of I/S flows in as the starting line item on the CFA.
Non-cash expenses such as D&A from the I/S are added back to
the cash flow from operations section.
Cash Flow Statement ↔ Balance Sheet (B/S):
Changes in net working capital (Money for running everyday
business) on the B/S are reflected in CFO.
CapEx is reflected in the CFI, which impacts PP&E on the B/S.
The impacts of debt or equity issuances are reflected in CFF.
The ending cash on the CFS flows into the cash line item on the
current period B/S.
Balance Sheet ↔ Income Statement:
Net income flows into retained earnings in the shareholders
equity section of the B/S.
Interest expense on the balance sheet is calculated based on the
difference between the beginning and ending debt balances on
the B/S.
PP&E on the balance sheet is impacted by the depreciation
expense on the balance sheet, and intangible assets are
impacted by the amortization expense.
Changes in common stock and treasury stock (i.e. share
repurchases) impact EPS on the income statement.
P.S. I know its confusing. It’s for me too, So any error can be found :(
Q. How would a $10 increase in depreciation
impact all the three statements?
06
A. The 3 income statements are interlinked with each other.
For Ex: Increase in Interest payment > Lowers PAT (I/S) > Less
Retained Earnings (B/S) > Low CFO (CFS)> Cash outflow from CFF.
The depreciation case:
Income Statement:
A $10 depreciation expense is recognized on the income statement,
which reduces EBIT by $10. Assuming a 20% tax rate, net income
would decrease by $8 [$10 - ( 10 * 20%)].
Cash Flow Statement:
The $8 decrease in net income flows into the top of the cash flow
statement, where the $10 depreciation expense is then added back
to the cash flow from operations since it is a non-cash expense.
Thus, the ending cash balance increases by $2.
Balance Sheet:
The $2 increase in cash flows to the top of the balance sheet, but
PP&E is decreased by $10 due to depreciation, so the assets side
declines by $8.
The $8 decrease in assets is matched by the $8 decrease in
retained earnings due to net income decreasing by that amount,
thereby the two sides remain in balance.
Q. If you have a balance sheet and must
choose between the income statement or the
cash flow statement, which would you pick?
07
If I have the beginning and end of period balance sheets, I would
choose the income statement since I can reconcile the cash flow
statement using the other statements.
Cash Flow Statement is prepared with the inputs from the I/S and
B/S hence we should select these two statements and prepare
accordingly.
Q. How would a $10 increase in depreciation
impact all the three statements?
Cost of Goods Sold: Represents direct costs that are associated
with the production of the goods that the company sells or the
services it delivers.
You have to incur these costs to manufacture the good and bring it
to a tangible form. It’s main components are Materials, Labor &
Manufacturing overheads.
Operating Expenses:
The costs incurred to make the product available to the customers
and run the operations smoothly. EBITDA comes after this.
Often called indirect costs, operating expenses refer to the costs
that are not directly associated with the production or manufacturing
of goods or services. Common types include SG&A and R&D.
Q. What is working capital?
08
The working capital metric measures the liquidity of a company, i.e.
its ability to pay off its current liabilities using its current assets.
It’s basically the capital needed to run the everyday operations of the
company.
You must invest this much money in your company as WC to keep it
going.
If a company has more working capital, then it will have less liquidity
risk – all else being equal.
Working Capital = Current Assets – Current Liabilities
Note that the formula shown above is the “textbook” definition of
working capital.
In practice, the working capital metric excludes cash and cash
equivalents like marketable securities, as well as debt and any
interest-bearing liabilities with debt-like characteristics.
Working capital need increases as AR rises by rise in credit sales.
Suppose sales are increasing and your AR (credit sales) are
increasing at a higher rate it means you aren’t able to recover your
debtors which is bad.
Working Capital needs to be managed very efficiently.
Q. What are some of the most common
margins used to measure profitability?
09
Gross Margin: The percentage of revenue remaining after
subtracting the company’s direct costs (COGS).
Gross Margin = (Revenue – COGS) / (Revenue)
Operating Margin: The percentage of revenue remaining after
subtracting operating expenses such as SG&A from gross profit.
Operating Margin = (Gross Profit – OpEx) / (Revenue)
EBITDA Margin: The most commonly used margin is due to its
usefulness in comparing companies with different capital structures
(i.e. interest) and tax jurisdictions.
EBITDA Margin = (EBIT + D&A) / (Revenue)
Net Profit Margin: The percentage of revenue remaining after
accounting for all of the company’s expenses. Unlike other margins,
taxes and capital structure have an impact on the net profit margin.
Net Margin = (EBT – Taxes) / (Revenue)
Q. Explain the difference between Accrual vs
Cash Basis of Accounting?
10
These are two types of recording accounting transactions in the
books. Most of the companies follow the former one.
The difference is based when the company actually record the sale
(money inflow) or purchase (money outflow) in the books.
Cash Basis:
Record transactions only when cash is actually received or paid
Example situation: You purchased 100 units of a product and will pay
for it next month. No transaction recorded
Accrual Basis:
Record transactions when it occurs, even if cash is not received or
paid
In earlier example The Transaction will be recorded through an
accounts payable (liability) account.
11
Q. Explain in brief difference between
Deferred revenue and expenses Vs Accrued?
Deferred Revenue & Expenses:
When cash is received prior to earning revenue by delivering goods
or services, the company records to recognize unearned revenue.
Ex: Gift cards, Byju’s Reveune, Airline miles, Subscriptions to
newspaper and magazines.
Deferred Expenses is the amount paid in advance before using the
assets that will benefit for more than one period.
Like Prepayment of advertising, insurance, or rent becomes used up
over time.
Accrued Revenue & Expenses:
When revenues are earned but not yet recorded at the end of the
accounting period because cash changes hands after the service is
performed or goods delivered.
Ex: A company earned interest revenue from the bank on its
checking account and had not yet recorded it
Accrued expenses is the process of recognizing expenses before
the cash is paid. For Ex: Utility bill received in the mail for the month
just completed.
Q. What is a bank reconciliation statement and 12
what are the factors affecting it?
A bank reconciliation statement is a summary of matching entries in
bank statements of a company with its balances in the cash book.
The factors affecting it are:
Interest received from the bank but not entered in the
company's cash book
Cheques issued but not presented in the bank
Dishonoured cheques
Q. What is the difference between depreciation
and amortization?
Amortization and depreciation are two methods of calculating the
value for business assets over time.
Depreciation is the loss of value of tangible assets, like furniture and
fixtures, machinery, buildings, computers and electronic material. It is
like dividing the cost of the product over the useful life of the
product.
Amortization is writing off intangible assets, such as patents, loans
and goodwill.
The two accounting approaches also differ in how salvage value is
used, whether accelerated expensing is done, or how each are
shown on the financial statements.
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