INVESTMENT BANKING 400 QS - BASICS ONLY
QUESTIONS WITH COMPLETE SOLUTIONS.
5 most important accounting concepts you need to know Answer - 1. The 3
financial statements and what each one means
2. How the 3 statements link together and how to walk through questions
where one or multiple items change
3. Different methods of accounting - cash-based vs. accrual, and determining
when revenue and expenses are recognized
4. When to expense something and when to capitalize it. Not all expenses are
created equal
5. What individual items on the statements, like Goodwill, Other Intangibles
and Shareholders' Equity, actually mean.
1. Walk me through the 3 financial statements. Answer - The 3 major financial
statements are the Income Statement, Balance Sheet and Cash Flow
Statement.
The Income statement gives the company's revenue and expenses, and goes
down to Net Income, the final line of the statement.
The Balance Sheet shows the company's assets - its resources - such as Cash,
Inventory, PP&E, as well as Liabilities such as Debt and Accounts Payable, and
Shareholder's Equity. Assets must equal Liabilities plus Shareholders' Equity.
,Lastly, Cash Flow Statement begins with its Net Income, adjusts for non-cash
expenses and working capital changes, and then lists cash flow from investing
and financing activities, at the end, you see the company's net change in cash.
2. Can you give examples of major line items on each of the financial
statements? Answer - Income Statement has Revenue; Cost of Goods Sold;
SG&A (Selling, General, and Administrative Expenses); Operating Income;
Pretax Income; Net Income
Balance Sheet has Cash; Accounts Receivable; Inventory; Plants, Property, and
Equipment; Account Payable; Accrued Expenses; Debt; Shareholders' Equity
Cash Flow Statement has Net Income; Depreciation & Amortization; Stock-
Based Compensation; Changes in Operating Assets and Liabilities; Cash Flow
From Operations; Capital Expenditures; Cash Flow From Investing;
Sale/Purchase of Securities; Dividend Issued; Cash Flow From Financing
3. How do the 3 statements link together Answer - To tie the statements
together, Net Income from the Income statement flows into Shareholders'
Equity on the balance sheet, and into the top line of the Cash Flow Statement.
Changes to Balance Sheet items appear as working capital changes on the Cash
Flow statement, and investing and financing activities affect Balance Sheet
items such as PP&E, Debt, and Shareholders' Equity. The Cash and
Shareholders' Equity items on the Balance Sheet act as "plugs", with Cash
flowing in from the final line of the cash flow statement.
4. If I were stranded on a desert island, only had 1 statement and I wanted to
review the overall health of a company - which statement would I use and
why? Answer - It would be the Cash Flow Statement. It's because the Cash
Flow Statement shows the overall and a true picture of how much cash the
company is actually generating, independent of all the non-cash expenses you
,might have. And that is the #1 thing you care about when analyzing the overall
financial health of any business - its cash flow.
5. 2 statements to access a company's prospects - which 2 would I use and
why? Answer - It would be the Income statement and Balance Sheet. Because
you can create the cash flow statement using those two statements (with an
assumption that you have "before" and "after" versions of the Balance sheet
that correspond to the same period the Income Statement is tracking).
6. Walk me through how Depreciation going up by $10 would affect the
statements Answer - Income Statement Operating Income would go down by
$10, and assuming the income tax is 40%, the net income would decline by $6.
Cash Flow Statement now starts with the net income that is $6 lower than
before. However, since depreciation $10 is non-cash expense, it would be
added back; therefore, the overall net cash would be up by $4.
Lastly, Balance Sheet's asset - PP&E - is down by $10 however the Cash is up by
$4 due to the Cash Flow Statement.
Overall, Assets is down by $6. Since Net Income fell by $6, Shareholders' Equity
on the Liabilities & Shareholders' Equity side is down by $6 and both sides of
the Balance Sheet balance.
Always, go with Income statement -> Cash Flow Statement -> Balance Sheet
**Asset going up decreases Cash Flow, whereas a Liabilities going up increases
your Cash Flow**
, 7. If Depreciation is a non-cash expense, why does it affect the cash balance?
Answer - Although Depreciation is non-cash expense, it is tax-deductible. Since
taxes are a cash expense, Depreciation affects cash by reducing the amount of
taxes you pay.
8. Where does Depreciation usually show up on the Income Statement?
Answer - It could be a separate line, or it could be embedded in COGS or
Operating Expenses. Every company does it differently. The end result for
accounting questions is the same: Depreciation always reduces Pre-Tax Income.
9. What happens when Accrued Compensation goes up by $10? Answer -
Confirm that the accrued compensation is now being recognized as an expense
as opposed to just changing non-accrued to accrued compensation.
Assuming that is the case, Operating Expenses on the Income Statement go up
by $10, Pre-Tax Income goes down bu $10 and Net Income would go down by
$6 (if the income tax is 40%).
On the Cash Flow Statement, Net Income is down by $6, and Accrued
compensation will increase cash flow by $10, so overall Cash Flow from
Operations is up by $4 and the Net Change in Cash at the bottom is up by $4.
On the Balance Sheet, Cash is up by $4, so assets are up by $4. On the
Liabilities and equity, accrued compensation is a liability so liabilities are up by
$10 and retained earnings are down by $6 due to the Net Income.
10. What happens when Inventory goes up by $10, assuming you pay for it with
cash? Answer - Income statement: no changes
QUESTIONS WITH COMPLETE SOLUTIONS.
5 most important accounting concepts you need to know Answer - 1. The 3
financial statements and what each one means
2. How the 3 statements link together and how to walk through questions
where one or multiple items change
3. Different methods of accounting - cash-based vs. accrual, and determining
when revenue and expenses are recognized
4. When to expense something and when to capitalize it. Not all expenses are
created equal
5. What individual items on the statements, like Goodwill, Other Intangibles
and Shareholders' Equity, actually mean.
1. Walk me through the 3 financial statements. Answer - The 3 major financial
statements are the Income Statement, Balance Sheet and Cash Flow
Statement.
The Income statement gives the company's revenue and expenses, and goes
down to Net Income, the final line of the statement.
The Balance Sheet shows the company's assets - its resources - such as Cash,
Inventory, PP&E, as well as Liabilities such as Debt and Accounts Payable, and
Shareholder's Equity. Assets must equal Liabilities plus Shareholders' Equity.
,Lastly, Cash Flow Statement begins with its Net Income, adjusts for non-cash
expenses and working capital changes, and then lists cash flow from investing
and financing activities, at the end, you see the company's net change in cash.
2. Can you give examples of major line items on each of the financial
statements? Answer - Income Statement has Revenue; Cost of Goods Sold;
SG&A (Selling, General, and Administrative Expenses); Operating Income;
Pretax Income; Net Income
Balance Sheet has Cash; Accounts Receivable; Inventory; Plants, Property, and
Equipment; Account Payable; Accrued Expenses; Debt; Shareholders' Equity
Cash Flow Statement has Net Income; Depreciation & Amortization; Stock-
Based Compensation; Changes in Operating Assets and Liabilities; Cash Flow
From Operations; Capital Expenditures; Cash Flow From Investing;
Sale/Purchase of Securities; Dividend Issued; Cash Flow From Financing
3. How do the 3 statements link together Answer - To tie the statements
together, Net Income from the Income statement flows into Shareholders'
Equity on the balance sheet, and into the top line of the Cash Flow Statement.
Changes to Balance Sheet items appear as working capital changes on the Cash
Flow statement, and investing and financing activities affect Balance Sheet
items such as PP&E, Debt, and Shareholders' Equity. The Cash and
Shareholders' Equity items on the Balance Sheet act as "plugs", with Cash
flowing in from the final line of the cash flow statement.
4. If I were stranded on a desert island, only had 1 statement and I wanted to
review the overall health of a company - which statement would I use and
why? Answer - It would be the Cash Flow Statement. It's because the Cash
Flow Statement shows the overall and a true picture of how much cash the
company is actually generating, independent of all the non-cash expenses you
,might have. And that is the #1 thing you care about when analyzing the overall
financial health of any business - its cash flow.
5. 2 statements to access a company's prospects - which 2 would I use and
why? Answer - It would be the Income statement and Balance Sheet. Because
you can create the cash flow statement using those two statements (with an
assumption that you have "before" and "after" versions of the Balance sheet
that correspond to the same period the Income Statement is tracking).
6. Walk me through how Depreciation going up by $10 would affect the
statements Answer - Income Statement Operating Income would go down by
$10, and assuming the income tax is 40%, the net income would decline by $6.
Cash Flow Statement now starts with the net income that is $6 lower than
before. However, since depreciation $10 is non-cash expense, it would be
added back; therefore, the overall net cash would be up by $4.
Lastly, Balance Sheet's asset - PP&E - is down by $10 however the Cash is up by
$4 due to the Cash Flow Statement.
Overall, Assets is down by $6. Since Net Income fell by $6, Shareholders' Equity
on the Liabilities & Shareholders' Equity side is down by $6 and both sides of
the Balance Sheet balance.
Always, go with Income statement -> Cash Flow Statement -> Balance Sheet
**Asset going up decreases Cash Flow, whereas a Liabilities going up increases
your Cash Flow**
, 7. If Depreciation is a non-cash expense, why does it affect the cash balance?
Answer - Although Depreciation is non-cash expense, it is tax-deductible. Since
taxes are a cash expense, Depreciation affects cash by reducing the amount of
taxes you pay.
8. Where does Depreciation usually show up on the Income Statement?
Answer - It could be a separate line, or it could be embedded in COGS or
Operating Expenses. Every company does it differently. The end result for
accounting questions is the same: Depreciation always reduces Pre-Tax Income.
9. What happens when Accrued Compensation goes up by $10? Answer -
Confirm that the accrued compensation is now being recognized as an expense
as opposed to just changing non-accrued to accrued compensation.
Assuming that is the case, Operating Expenses on the Income Statement go up
by $10, Pre-Tax Income goes down bu $10 and Net Income would go down by
$6 (if the income tax is 40%).
On the Cash Flow Statement, Net Income is down by $6, and Accrued
compensation will increase cash flow by $10, so overall Cash Flow from
Operations is up by $4 and the Net Change in Cash at the bottom is up by $4.
On the Balance Sheet, Cash is up by $4, so assets are up by $4. On the
Liabilities and equity, accrued compensation is a liability so liabilities are up by
$10 and retained earnings are down by $6 due to the Net Income.
10. What happens when Inventory goes up by $10, assuming you pay for it with
cash? Answer - Income statement: no changes
