Wall Street Prep Accounting Questions
with complete solutions (graded A+)
What are the 3 financial statements, and why do we need them? -
answer The 3 major financial statements are the Income Statement,
Balance Sheet, and Cash Flow
Statement.
The Income Statement shows the company's revenue, expenses, and
taxes over a period and
ends with Net Income, which represents the company's after-tax
profits.
The Balance Sheet shows the company's Assets - its resources - as well
as how it paid for those
resources - its Liabilities and Equity - at a specific point in time. Assets
must equal Liabilities
plus Equity.
The Cash Flow Statement begins with Net Income, adjusts for non-cash
items and changes in
operating assets and liabilities (working capital), and then shows the
company's cash from
Investing or Financing activities; the last lines show the net change in
cash and the company's
ending cash balance.
,You need these statements because there is a big difference between a
company's Net Income
and the cash it generates - the Income Statement alone doesn't tell
what its cash flow is.
Remember the key valuation formula:
Company Value = Cash Flow / (Discount Rate - Cash Flow Growth Rate)
The 3 financial statements let you estimate the "Cash Flow" part, which
helps you value the
company more accurately.
How do the 3 statements link together? - answer To link the statements,
make Net Income from the Income Statement the top line of the Cash
Flow Statement.
Then, adjust this Net Income number for any non-cash items such as
Depreciation &
Amortization.
Next, reflect changes to operational Balance Sheet items such as
Accounts Receivable, which
may increase or decrease the company's cash flow depending on how
they've changed.
This gets you to Cash Flow from Operations.
Next, take into account investing and financing activities, which may
increase or decrease cash
,flow, and sum up Cash Flow from Operations, Investing, and Financing
to get the net change in
cash at the bottom.
Link Cash on the Balance Sheet to the ending Cash number on the CFS,
and add Net Income to
Retained Earnings within the Equity category on the Balance Sheet.
Then, link each non-cash adjustment to the appropriate Asset or
Liability; SUBTRACT links on
the Assets side and ADD links on the L&E side.
And then link each CFI and CFF item to the matching item on the
Balance Sheet, using the same
rule as above.
Check that Assets equals Liabilities plus Equity at the end; if this is not
true, you did something
wrong and need to re-check your work
What's the most important financial statement? - answer The Cash Flow
Statement is the most important single statement because it tells you
how much
cash a company is generating. The Income Statement is misleading
because it includes non-cash
revenue and expenses and excludes cash spending such as Capital
Expenditures.
, What if you could use only 2 statements to assess a company's
prospects - which ones
would you use, and why? - answer You would use the Income
Statement and Balance Sheet because you can create the Cash Flow
Statement from both of those (assuming there are "Beginning" and
"Ending" Balance Sheets
that correspond to the same period shown on the Income Statement)
It would be MUCH harder to "construct" an Income Statement from the
Balance Sheet and
Cash Flow Statement (for example).
How might the financial statements of a company in the U.K. or
Germany be different from
those of a company based in the U.S.? - answer Income Statements and
Balance Sheets tend to be similar across different regions, but
companies that use IFRS often start the Cash Flow Statement with
something other than Net
Income: Operating Income, Pre-Tax Income, or if they are using the
Direct Method for creating
the CFS, Cash Received or Cash Paid.
There are also minor naming differences; for example, the Income
Statement might be called
with complete solutions (graded A+)
What are the 3 financial statements, and why do we need them? -
answer The 3 major financial statements are the Income Statement,
Balance Sheet, and Cash Flow
Statement.
The Income Statement shows the company's revenue, expenses, and
taxes over a period and
ends with Net Income, which represents the company's after-tax
profits.
The Balance Sheet shows the company's Assets - its resources - as well
as how it paid for those
resources - its Liabilities and Equity - at a specific point in time. Assets
must equal Liabilities
plus Equity.
The Cash Flow Statement begins with Net Income, adjusts for non-cash
items and changes in
operating assets and liabilities (working capital), and then shows the
company's cash from
Investing or Financing activities; the last lines show the net change in
cash and the company's
ending cash balance.
,You need these statements because there is a big difference between a
company's Net Income
and the cash it generates - the Income Statement alone doesn't tell
what its cash flow is.
Remember the key valuation formula:
Company Value = Cash Flow / (Discount Rate - Cash Flow Growth Rate)
The 3 financial statements let you estimate the "Cash Flow" part, which
helps you value the
company more accurately.
How do the 3 statements link together? - answer To link the statements,
make Net Income from the Income Statement the top line of the Cash
Flow Statement.
Then, adjust this Net Income number for any non-cash items such as
Depreciation &
Amortization.
Next, reflect changes to operational Balance Sheet items such as
Accounts Receivable, which
may increase or decrease the company's cash flow depending on how
they've changed.
This gets you to Cash Flow from Operations.
Next, take into account investing and financing activities, which may
increase or decrease cash
,flow, and sum up Cash Flow from Operations, Investing, and Financing
to get the net change in
cash at the bottom.
Link Cash on the Balance Sheet to the ending Cash number on the CFS,
and add Net Income to
Retained Earnings within the Equity category on the Balance Sheet.
Then, link each non-cash adjustment to the appropriate Asset or
Liability; SUBTRACT links on
the Assets side and ADD links on the L&E side.
And then link each CFI and CFF item to the matching item on the
Balance Sheet, using the same
rule as above.
Check that Assets equals Liabilities plus Equity at the end; if this is not
true, you did something
wrong and need to re-check your work
What's the most important financial statement? - answer The Cash Flow
Statement is the most important single statement because it tells you
how much
cash a company is generating. The Income Statement is misleading
because it includes non-cash
revenue and expenses and excludes cash spending such as Capital
Expenditures.
, What if you could use only 2 statements to assess a company's
prospects - which ones
would you use, and why? - answer You would use the Income
Statement and Balance Sheet because you can create the Cash Flow
Statement from both of those (assuming there are "Beginning" and
"Ending" Balance Sheets
that correspond to the same period shown on the Income Statement)
It would be MUCH harder to "construct" an Income Statement from the
Balance Sheet and
Cash Flow Statement (for example).
How might the financial statements of a company in the U.K. or
Germany be different from
those of a company based in the U.S.? - answer Income Statements and
Balance Sheets tend to be similar across different regions, but
companies that use IFRS often start the Cash Flow Statement with
something other than Net
Income: Operating Income, Pre-Tax Income, or if they are using the
Direct Method for creating
the CFS, Cash Received or Cash Paid.
There are also minor naming differences; for example, the Income
Statement might be called
