Finance Technical Interview Quick Bite - 3 Statements Accounting

TLDR

- 3 Statement accounting sucks

- Read my notes and internalized it :)

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Foreword

One of the trickiest parts of preparing for technical interviews is how to quickly answer questions on how changes to certain items of the income statement will flow through the rest of the statements (cash flow, balance sheet). But you shall not worry, in the below, I have outlined some of the most common questions that you might encounter during an interview. In most cases, we will start by talking about the impact of the income statement, then how that flows into the cash flow statement, and finally, you will talk about the changes to both asset and liabilities + equity side in order to show that the changes balance each other out.

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Notes are outlined below: (Tax rate is assumpted @ 40%)

• Balance Sheet Changes

  • A/R +100 (If AR goes up, it means that you have recorded revenue but not collected it in cash from customers yet. You’ve delivered the product/service, but they haven’t paid you in cash yet... but you record it as revenue anyway.)

    • Rev + 100, NI +60

    • CFO is (40) because NI +60 but changes in AR caused CFO to go down by 100

    • B/S: Asset +60 [Cash(40) but A/R +100], SE +60

  • A/R (100) (If AR goes down, that means you’ve collected the cash from customers that owe you. So nothing on the IS changes – it’s only a cash collection and your cash goes up.)

    • Cash + 100 and A/R (100)

  • Prepaid Expenses +100 (When Prepaid Expenses goes up, you pay in advance, in cash, for a future product or service but you do not record the expense on the Income Statement yet because it hasn’t been delivered yet) [e.g prepaid insurance]

    • Cash (100), Prepaid Expense +100

  • Prepaid Expenses (100) (When Prepaid Expense goes down, you now record on the Income Statement the expense that you previously paid in cash. So the IS changes, and so do a number of BS items)

    • NI (60)

    • CFO +40 (NI(60), changes in prepaid expenses +100)

    • B/S: Assets (60) [Cash and Prepaid Expenses), SE (60) [NI down 60]

  • Inventory +100 (When Inventory goes up, that means that you’ve purchased products but have not manufactured or sold anything yet. Therefore, nothing on the IS changes and only Inventory and Cash on the BS change.)

    • Cash (100), Inventory +100

  • Inventory (100) (When Inventory goes down, that means that you’ve now turned it into finished products and sold it to customers... so expenses on the IS increase to reflect the cost of these goods)

    • NI (60) because COGS went up by 100 (assumed 40% tax rate)

    • CFO +40 [NI(60) but inventory increase CF by 100]

    • B/S: Asset (60) [Cash +40 but Inventory (100)]; SE (60) [NI (60)]

  • Accrued Expenses +100 (When Accrued Expenses goes up, it means that we’ve recorded an expense on the Income Statement but haven’t paid it out in cash yet.

    • NI (60) because expense goes up by 100

    • CFO +40 (NI(60) but accrued expense add 100 to CFO)

    • B/S: Asset +40 (Cash); Liab +100 ; SE (60) because NI(60)

  • Accrued Expenses -100 (When Accrued Expenses goes down, it means we’ve now paid out in cash an expense that was previously recorded on the IS... so nothing on the Income Statement changes.)

    • Cash (100); Accrued Expense (100) [Liability]

  • Account Payable +100 (we’ve received a product/service, recorded it as an expense on the IS, but haven’t paid for it in cash yet.)

    • NI (60) because expense +100

    • CFO +40 (NI(60) but A/P +100)

    • B/S: Assets +40; Liab +100; SE (60)

  • Account Payable (100) (The same as Accrued Expenses: when it decreases, that signifies a cash payout of an expense that was previously recorded on the IS.)

    • Cash (100); Liab (100)

  • Deferred Revenue +100 (When Deferred Revenue goes up, it means that we’ve collected cash from customers for a product/service, but haven’t recorded it as revenue yet – so there are no changes on the Income Statement.)

    • Cash +100, Liab +100

  • Deferred Revenue (100) (When Deferred Revenue goes down, it means that now we’re recognizing this previously collected cash in the form of revenue, so the Income Statement changes.)

    • NI +60 because Rev +100

    • CFO (40) because NI +60 but def revenue (100)

    • B/S: Asset (40) because of Cash; Liab (100); SE +60 (NI)

  • Debt Write-down (100) (When liability is written down, you record it as a gain on the I/S, when Asset is written down, you record as a loss)

    • NI +60 because record write down as a gain

    • CFO (40) because NI +60 but subtract the debt write-down of (100)

    • B/S: Asset (40) because of Cash; Liab (100) and NI (SE) +60

  • Equity Bail-Out (+100)

    • No changes to I/S

    • CFF + 100

    • B/S: Asset +100 because of Cash; SE +100 because of equity injection

Hopefully, the outline above helps to memorize accounting changes a little more tolerable.