Accounting Interview Questions

Q. Walk me through the income statement.

The income statement 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.

Q. Walk me through the balance sheet.

The balance sheet shows a company’s financial position – the carrying value of its assets, liabilities, and equity – at a specific point in time.

Since a company’s assets have to have been funded somehow, assets must always equal the sum of liabilities and shareholders’ equity.

• 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.
• 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 (APIC), 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?

• Assets: The resources with positive economic value that can be exchanged for money or bring positive monetary benefits in the future.
• Liabilities: The outside sources of capital that have helped fund the company’s assets. These represent unsettled financial obligations to other parties.
• 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.

Q. Walk me through the cash flow statement.

The cash flow statement summarizes a company’s cash inflows and outflows over a period of time.

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: From net income, 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: Captures long-term investments made by the company, primarily capital expenditures (CapEx) as well as any acquisitions or divestitures.
• Cash Flow from Financing Activities: 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 would a $10 increase in depreciation impact the three statements?

1. Income Statement: A $10 depreciation expense is recognized on the income statement, which reduces operating income (EBIT) by $10. Assuming a 20% tax rate, net income would decrease by $8 [$10 – (1 – 20%)].
2. 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.
3. 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.

Note: If the interviewer does not state a tax rate, ask what tax rate is being used. For this example, we assumed a tax rate of 20%.

Q. How are the three financial statements connected?

Income Statement ↔ Cash Flow Statement

• Net income on the income statement flows in as the starting line item on the cash flow statement.
• Non-cash expenses such as D&A from the income statement are added back to the cash flow from operations section.

Cash Flow Statement ↔ Balance Sheet

• The changes in net working capital on the balance sheet are reflected in cash flow from operations.
• CapEx is reflected in the cash flow statement, which impacts PP&E on the balance sheet.
• The impacts of debt or equity issuances are reflected in the cash flows from financing section.
• The ending cash on the cash flow statement flows into the cash line item on the current period balance sheet.

Balance Sheet ↔ Income Statement

• Net income flows into retained earnings in the shareholders’ equity section of the balance sheet.
• Interest expense on the balance sheet is calculated based on the difference between the beginning and ending debt balances on the balance sheet.
• 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.

Q. If you have a balance sheet and must choose between the income statement or the cash flow statement, which would you pick?

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.

Q. What is the difference between the cost of goods sold (COGS) and operating expenses (OpEx) line item?

• 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.
• Operating Expenses: 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 are some of the most common margins used to measure profitability?

• 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. What is working capital?

The working capital metric measures the liquidity of a company, i.e. its ability to pay off its current liabilities using its current assets.

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.