Breaking into Wall Street 400 Guide-
Questions and Correct Answers
Walk me through the three financial statements ✅Income Statement, Balance Sheet,
Cash Flow Statement
Income Statement: Details the company's revenue and expenses to arrive to net income
Balance Sheet: Details the distribution of a company's assets, liabilities, and
shareholder's equity. Assets must equal liabilities plus shareholders equity.
Cash Flow Statement: Starts with net income and adjusts for cash inflows and outflows
of operating, investing, and financing activities to arrive at the company's net change in
cash.
Major line items on income statement ✅Revenue, COGS, SG&A, Operating Income,
Pretax Income, Net Income
Major line items on balance sheet ✅Cash, Accounts Receivable, Inventory, PP&E,
Accounts Payable, Accrued Expenses, Debt, Shareholders Equity
major line items on cash flow statement ✅Cash Flow from Operations, Cash Flows
from Investing, Cash Flow from Financing:
Net Income, Depreciation & Amortization, Changes in Operating Assets & Liabilities,
Capital Expenditures, Sale/Purchase of Securities; Dividends Issued
How do the three statements link together? ✅To tie the statements together...
- Net Income from the Income Statement is reflected on the first line of the Cash Flow
Statement.
- Net change in Cash Flows on the Cash Flow Statement is reflected in assets of the
Balance Sheet
- Investing and Financing activities on the Cash Flow Statement affect Balance Sheet
items such as PP&E, Debt, and Shareholders' Equity
- Retained Earnings in Shareholders' Equity on the Balance Sheet comes from net
income on the Income Statement
If I were stranded on a desert island and only had one financial statement and I wanted
to review the overall health of a company, which statement would I use and why?
✅Cash Flow Statement
CFS gives the true picture of how much cash the company is actually generating,
independent of all the non-cash expenses you might have. And cash flow is #1 thing
you care about in analyzing financial health of a business.
If you could look at 2 statements, which two would you use and why? ✅Income
Statement and Balance Sheet
,The income statement and balance sheet can be combined to create the CFS
(assuming you have "before" and "after" versions of balance sheet corresponding to
period income statement tracks)
Walk me through how depreciation going up by $10 would affect the statements? ✅IS:
Pre-Tax income would decline by $10, and assuming a 40% tax rate, net income would
go down by $6 because of reduced tax expense
CFS: at the top, net income goes down by $6, but after accounting for the $10
depreciation, which is a non-cash expense that gets added back, overall cash flow from
operations goes up by $4. There are no changes elsewhere, so the overall net change
in cash goes up by $4.
BS: Cash is up by $4 from changes on CFS. PP&E goes down by $10 in assets
because of depreciation. Since net income fell by $6, shareholders' equity is also down
by $6.
Since assets = liabilities + shareholders' equity, the balance sheet balances
*Remember that an asset going up decreases your cash flow, whereas a liability going
up increases your cash flow
If Depreciation is a non-cash expense, why does it affect the cash balance? ✅Because
it is tax-deductibale. Since taxes are a cash expense, depreciation affects cash by
reducing taxes.
Where does depreciation usually show up on the income statement? ✅Every company
reports depreciation differently
It could be in a separate line item, or it could be embedded in COGS or operating
expenses
*End result for accounting questions is the same: depreciation always reduces pre-tax
income
What happens when accrued compensation goes up by $10? ✅Operating expenses
on the income statement go up by $10, pre-tax income falls by $10, and net income falls
by $6 (assuming a 40% tax rate).
On CFS, net income is down by $6, accrued compensation will increase cash flow by
$10, so overall cash flow from operations is up by $4 and net change in cash at the
bottom is up by $4.
On BS, cash is up by $4, so assets are up by $4. Accrued compensation is a liability so
liabilities are up by 10 and retained earnings are down by $6 due to the net income, so
liabilities + shareholders' equity = 4, and the balance sheet balances.
,What happens when inventory goes up by $10, assuming you pay for it with cash?
✅No changes to IS.
On cash flow statement, inventory is an asset so that decreases your cash flow from
operations, which goes down by $10, as does net change in cash at the bottom.
On balance sheet under assets, inventory up by $10 but cash is down by $10, so
changes cancel out and assets still equals liabilities & shareholders' equity.
Why is the income statement not affected by changes in inventory? ✅*working capital
changes do not show up on the income statement*
Inventory expense is only recorded when the goods associated with it are sold. So if it's
just sitting in a warehouse, it does not count as a cost of goods sold or operating
expense until the company manufactures it into a product and sells it.
Let's say Apple is buying $100 worth of new ipod factories with debt. How are all 3
statements affected at the start of Year 1, before anything else happens? ✅No
changes yet to IS at start of year 1.
On CFS, additional investment in factories would show up under cash flow from
investing as a net reduction in cash flow of $100 so far. But the additional $100 worth of
debt raised would show up as an addition to cash flow, canceling out investment
activity. So cash number stays the same.
On BS there is now $100 worth of factories in PP&E, so assets is up by $100. On the
other side, debt is up by $100 as well so both sides balance
Now going out 1 year to start of year 2. Assume debt is high yield so no principal is paid
off, and assume an interest rate of 10%. Also assume factories depreciate at a rate of
10% per year. What happens? ✅Apple must pay interest expense and must record the
depreciation.
Pre-Tax income decreased by $20: $10 from 10% depreciation and $10 in interest
expense
Assuming 40% tax rate, net income would fall by $12 (20-20*.4)
On CFS, net income has decreased by $12. Depreciation is a non-cash expense, and
cash flow from operations is down by $2
That's only change on CFS, so overall cash is down by $2.
On BS, under assets, cash is down $2, and PP&E is down $10 from depreciation, so
assets are down by $12 total.
Since net income was down by $12, shareholders' equity is also down by $12, and both
sides balance.
*Debt under liabilities only changes when the debt is paid back
, At the start of Year 3, the factories all break down and the value of the equipment is
written down to $0. The loan must also be paid back now. Walk me through the 3
statements. ✅After 2 years, the value of the factories is now $80 if we go with the 10%
depreciation per year assumption. It is this $80 that we will write down in the 3
statements.
On IS, the $80 write-down shows up in the pre-tax income line. With 40% tax rate net
income declines by $48.
On the CFS, net income down $48 but write-down is a non-cash expense, so we add it
back, and cash flow from operations increases by $32.
No changes under cash flow from investing, but under cash flow from financing there is
a $100 charge for the loan payback, so cash flow from investing falls by $100.
Thus, overall net change in cash falls by $68.
BS: cash down by $68 and PP&E down by $80, so assets decreased by $148.
On other side, debt down $100 since it was paid off, and since net income dropped by
$48, shareholders' equity down by $48 as well. Liabilities and shareholders' equity down
by $148 so both sides balance.
Now looking at a different scenario, assume Apple is ordering $10 of additional Ipod
inventory using cash on hand. They order inventory but have not manufactured or sold
anything yet. What happens to 3 statements? ✅IS: no changes
CFS: inventory up by $10, so cash flow from operations decreases by $10. No further
changes so cash down by $10 overall.
BS: inventory up by $10 and cash down by $10 so assets number stays same and BS
remains in balance.
Now say they sell Ipods for revenue of $20 at a cost of $10. Walk me through the 3
statements under this scenario. ✅IS: revenue up by $20 and COGS up by $10, so
gross profit is up by $10 and operating income is up by $10 as well. Assuming 40% tax
rate, net income is up by $6.
CFS: net income at top up by $6 and inventory has decreased by $10, but that's a net
addition to cash flow. So cash flow from operations is up by $16. Thus, net change in
cash is up by $16.
BS: cash up by $16 and inventory down by $10, so assets are up by $6.
On the other side, net income was up by $6 so shareholders' equity is up by $6 and
both sides balance.
Can you ever end up with negative shareholders' equity? What does it mean? ✅1.
Leveraged buyouts with dividend recapitalizations - where the owner of the company
