Accounting Interview Questions for Finance

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The three main financial statements are the Income Statement, the Balance Sheet, and the Cash Flow Statement.

• The Income Statement shows a company’s performance over a specific period, summarizing revenues, expenses, and ultimately net income after taxed. It answers the question: Did the company make a profit?
• The Balance Sheet provides a snapshot of a company’s financial position at a specific point in time. It lists assets (in terms of resources such as Cash, Inventory and PP&E), liabilities (such es debt and accounts payable), and shareholders’ equity, following the equation: Assets = Liabilities + Equity.
• The Cash Flow Statement tracks how cash moves through the business. It starts with net income, adjusts for non-cash expenses like depreciation and changes in working capital (operating assets and liabilities), and then shows cash flows from operating, investing, and financing activities. At the end, it reconciles to the net change in cash on the Balance Sheet.

Together, these statements give a comprehensive view of a company’s financial health and performance.

The three financial statements are closely linked, and changes in one often flow through to the others. Here's how they connect:

1. Net Income from the bottom of the Income Statement flows into the top of the Cash Flow Statement as the starting point for cash from operations.
2. On the Cash Flow Statement, we then add back non-cash expenses like depreciation and amortization from the Income Statement, and we adjust for non-operating items like gains or losses on asset sales by flipping their signs.
3. Next, we adjust for changes in operating assets and liabilities (working capital) from the Balance Sheet. The rule of thumb is:
   • If an asset increases, cash flow decreases
   • If a liability increases, cash flow increases, and vice versa.
4. In Cash Flow from Investing, we account for capital expenditures (like purchases of PP&E) and investment activities (buying or selling marketable securities).
5. Cash Flow from Financing includes debt and equity transactions, such as issuing or repurchasing stock, raising or repaying debt, and paying dividends.
6. The net change in cash from all three sections of the Cash Flow Statement is then used to update the cash balance on the Balance Sheet for the next period.
7. Finally, the Balance Sheet is updated to reflect changes in cash, debt, equity, PP&E, and other items that were adjusted on the Cash Flow Statement.

This linkage ensures that the three statements form a self-reinforcing system that reflects both the company’s performance and how that performance impacts its financial position and liquidity.

The Cash Flow Statement is the most informative for assessing a company’s financial health:

• Shows actual cash generation, so reveals how much real cash the business is producing.
• Strips out accounting noise and avoids distortions from non-cash items like depreciation or gains/losses.
• Covers all key activities:
  • Operating: Core business cash flow
  • Investing: Capital expenditures, asset sales/purchases
  • Financing: Debt raised/paid, dividends, equity changes
• Highlights liquidity and sustainability and answers the fundamental question: Can the company fund itself and grow?
• More reliable than the Income Statement, which may show profits but hide cash problems.

If two financial statements were available, the most useful combination would be the Income Statement and the Balance Sheet.

• Together, they provide insight into profitability (Income Statement) and financial position (Balance Sheet).
• With these two, it's possible to approximate a Cash Flow Statement, assuming beginning and ending Balance Sheets are available for the same period as the Income Statement.
• By comparing changes in Balance Sheet items and combining that with net income, one can estimate operating cash flow, capital expenditures, and even financing activities (e.g., changes in debt or equity).
• This makes them a powerful pair for analyzing a company's performance and financial health, even without direct cash flow data.

Before starting, it's important to clarify the applicable corporate tax rate with the interviewer. For this example, let’s assume a 20% tax rate.

Let’s walk through how a $25,000 increase in depreciation expense affects all three financial statements:

At this point, Tesla hasn’t earned or spent anything operationally. The company is simply investing in a new asset (the factory) and financing it with debt.

Income Statement:

• No changes yet. Buying a factory is a capital investment, not an expense, so it does not show up on the Income Statement.
• No depreciation or interest expense has been incurred yet.

Cash Flow Statement:

• Investing Activities: –$100M due to capital expenditure for building the factory.
• Financing Activities: +$100M from taking on new debt to fund the factory.
• Cash Flow from Operations: No change yet.
• Net change in cash = $0 → Money goes out to build the factory, but comes in from debt, so they cancel each other out.

Balance Sheet:

• Assets: PPE (Property, Plant & Equipment) increases by $100M.
• Liabilities: Debt increases by $100M.
• Equity: No change yet (no income or retained earnings impact).
• Both sides increase by $100M → The Balance Sheet stays balanced.

Now that the factory is up and running, Tesla starts depreciating the asset and paying interest on the debt.

Assumptions:

• The factory depreciates at 10% per year = $10M/year
• The debt has a 10% interest rate, with no principal repayment = $10M/year
• Corporate tax rate = 20%

In Year 2, the facility’s depreciation and interest expense will affect Tesla’s financial statements, with changes to net income, cash flow, and asset values. The following breakdown will examine the impact on the Income Statement, Cash Flow Statement, and Balance Sheet in detail.

By this point:

• After two years of 10% depreciation, the factory’s book value = $80M
• That $80M is now written off completely
• The loan is repaid in full

At the end of Year 2, the facility is written down to $0 due to damage, and Tesla repays the full loan. This results in impacts across all three financial statements, including adjustments to the Income Statement, Cash Flow Statement, and Balance Sheet.