Wall Street Prep
"Company A has $100 of assets while company B has $200 of assets. Which company should have a
higher value?" - ANS-On the face of it, we simply don't have enough information to answer this question.
We need certain efficiency and profitability ratios to understand how the companies are using assets to
generate revenues.
You: Given that we only know the total amount of assets for both company A and B and nothing else, it is
impossible to say whether A or B is more valuable. Would I be able to ask you some questions about
both companies?
Interviewer: Sure
You: Would you be able to tell me what industry these two companies operate in?
Interviewer: They are both consumer products companies.
You: Can I assume that both companies have similar expected asset turnover (revenue/assets), leverage,
return on asset, re-investment rates and profit margins?
Interviewer: Yes, let's assume this is correct.
You: Okay, thank you. Based on this information, it appears that we are comparing two companies with
similar returns on capital, long term growth rates, and costs of capital. Since these elements are the
primary drivers of value for a business, as long as both companies generate returns above their cost of
capital, the firm with the larger assets deserves a higher valuation because they are both effectively
"converting" their assets into profitability with equal efficiency, given similar risks and expected growth.
"Why is the cash flow statement important and how does it compare to the income statement?" - ANS-
The income statement shows a company's accounting-based profitability. It illustrates a company's
revenues, expenses, and net income. Income statement accounting uses what is called accrual
, accounting. Accrual accounting requires that businesses record revenue when earned and expenses
when incurred.
Under accrual method, revenues are recognized when earned - not necessarily when cash is received -
while expenses are matched to associated revenue - again not necessarily when cash goes out the door.
The benefit of the accrual method is that it strives to show a more accurate picture of the companies
profitability. However, focusing on accrual based profitability without looking at cash inflows and
outflows is very dangerous, not only because companies can more easily manipulate accounting profits
than they can cash profits, but also because not having a handle on cash can potentially make even a
healthy company go bankrupt.
Those shortcomings are addressed by focusing on the cash flow statement. The cash flow statement
identifies all of the cash inflows and outflows of a business over a certain period of time. The statement
utilizes cash accounting. Cash accounting is the system used to keep track of actual cash inflows and
outflows. What this really means is that since not all transactions are made with cash (i.e., accounts
receivable), such transactions would be backed out of the cash flow statement.
Cash accounting literally tracks the cash coming into and out of the business. One final point on cash vs.
accrual accounting is that the differences between the two accounting systems are temporary timing
differences that will eventually converge.
The key to financial analysis is to use both statements together. In other words, if you have incredibly
high net income, such net income should be supported by strong cash
Addressing a low GPA - ANS-"Frankly, I made some bad decisions as a freshman which I have been able
to partially reverse through a lot of hard work over the last few years. My very 1st semester at Notre
Dame I did not manage my time well between extracurricular activities and academics and received a
1.8. After reflecting on my poor performance that semester, I realized that I needed to get my priorities
in order and started to focus more of my energy on my academics. Excluding that first semester, my GPA
would have been 3.5. In fact, I have continued to improve every year and over the last year I have
maintained a 3.8 GPA."
Assets - ANS-resources a company uses to operate its business
includes cash, A/R, PP&E
"Company A has $100 of assets while company B has $200 of assets. Which company should have a
higher value?" - ANS-On the face of it, we simply don't have enough information to answer this question.
We need certain efficiency and profitability ratios to understand how the companies are using assets to
generate revenues.
You: Given that we only know the total amount of assets for both company A and B and nothing else, it is
impossible to say whether A or B is more valuable. Would I be able to ask you some questions about
both companies?
Interviewer: Sure
You: Would you be able to tell me what industry these two companies operate in?
Interviewer: They are both consumer products companies.
You: Can I assume that both companies have similar expected asset turnover (revenue/assets), leverage,
return on asset, re-investment rates and profit margins?
Interviewer: Yes, let's assume this is correct.
You: Okay, thank you. Based on this information, it appears that we are comparing two companies with
similar returns on capital, long term growth rates, and costs of capital. Since these elements are the
primary drivers of value for a business, as long as both companies generate returns above their cost of
capital, the firm with the larger assets deserves a higher valuation because they are both effectively
"converting" their assets into profitability with equal efficiency, given similar risks and expected growth.
"Why is the cash flow statement important and how does it compare to the income statement?" - ANS-
The income statement shows a company's accounting-based profitability. It illustrates a company's
revenues, expenses, and net income. Income statement accounting uses what is called accrual
, accounting. Accrual accounting requires that businesses record revenue when earned and expenses
when incurred.
Under accrual method, revenues are recognized when earned - not necessarily when cash is received -
while expenses are matched to associated revenue - again not necessarily when cash goes out the door.
The benefit of the accrual method is that it strives to show a more accurate picture of the companies
profitability. However, focusing on accrual based profitability without looking at cash inflows and
outflows is very dangerous, not only because companies can more easily manipulate accounting profits
than they can cash profits, but also because not having a handle on cash can potentially make even a
healthy company go bankrupt.
Those shortcomings are addressed by focusing on the cash flow statement. The cash flow statement
identifies all of the cash inflows and outflows of a business over a certain period of time. The statement
utilizes cash accounting. Cash accounting is the system used to keep track of actual cash inflows and
outflows. What this really means is that since not all transactions are made with cash (i.e., accounts
receivable), such transactions would be backed out of the cash flow statement.
Cash accounting literally tracks the cash coming into and out of the business. One final point on cash vs.
accrual accounting is that the differences between the two accounting systems are temporary timing
differences that will eventually converge.
The key to financial analysis is to use both statements together. In other words, if you have incredibly
high net income, such net income should be supported by strong cash
Addressing a low GPA - ANS-"Frankly, I made some bad decisions as a freshman which I have been able
to partially reverse through a lot of hard work over the last few years. My very 1st semester at Notre
Dame I did not manage my time well between extracurricular activities and academics and received a
1.8. After reflecting on my poor performance that semester, I realized that I needed to get my priorities
in order and started to focus more of my energy on my academics. Excluding that first semester, my GPA
would have been 3.5. In fact, I have continued to improve every year and over the last year I have
maintained a 3.8 GPA."
Assets - ANS-resources a company uses to operate its business
includes cash, A/R, PP&E
