Investment Banker interview questions

The income statement shows profitability, the cash flow statement explains the change in cash, and the balance sheet shows what the company owns and owes at a point in time.

• The income statement runs from revenue through expenses to net income over a period.
• The cash flow statement reconciles net income to cash from operating, investing, and financing activities.
• The balance sheet reports assets, liabilities, and equity, with assets equal to liabilities plus equity.
• Together they distinguish accounting earnings from cash generation and the resources used to produce them.

Net income links the income statement to both the cash flow statement and retained earnings on the balance sheet.

• The cash flow statement starts with net income, adds back noncash items, and reflects working capital, investing, and financing movements.
• Ending cash from the cash flow statement becomes cash on the balance sheet.
• Capital expenditures add to property, plant, and equipment, while depreciation reduces it.
• Debt issuance and repayment change both financing cash flow and the balance sheet debt balance.

Net income falls by $7.5, but cash increases by $2.5 because depreciation is noncash and creates a tax shield.

• EBIT and pre-tax income each fall by $10, taxes fall by $2.5, and net income falls by $7.5.
• On the cash flow statement, the $10 depreciation add-back offsets the lower net income, so operating cash flow rises by $2.5.
• On the balance sheet, cash rises by $2.5 and net PP&E falls by $10.
• Retained earnings fall by $7.5, so both sides of the balance sheet decline by a net $7.5.

At purchase, there is no income statement effect because the inventory has not yet been sold.

• On the cash flow statement, the $20 increase in inventory reduces cash from operations by $20.
• On the balance sheet, inventory rises by $20 and cash falls by $20.
• Total assets do not change, and liabilities and equity are unchanged.
• The expense reaches the income statement later through cost of goods sold when the inventory is sold.

Cash and a liability both rise by $12 because the company has collected payment before earning the revenue.

• The income statement has no immediate effect until the company delivers the product or service.
• The cash flow statement shows a $12 operating cash inflow through the increase in deferred revenue.
• On the balance sheet, cash rises by $12 and deferred revenue rises by $12.
• As the obligation is fulfilled, revenue is recognized and the deferred revenue liability declines.

Capital expenditure uses investing cash immediately and is expensed gradually through depreciation.

• The cash flow statement records the full purchase as an investing outflow.
• The balance sheet adds the purchase to gross PP&E and reduces cash by the amount paid.
• The income statement later records depreciation over the asset's useful life.
• Depreciation reduces net PP&E and net income but is added back in operating cash flow because it is noncash.

I would build explicit balance and cash roll-forward checks rather than rely on visual inspection.

• The balance sheet check should calculate assets minus liabilities and equity and equal zero in every period.
• Beginning cash plus the period's net change in cash should equal ending cash on the balance sheet.
• Debt, retained earnings, and PP&E schedules should reconcile beginning balance, movements, and ending balance.
• I would flag any nonzero check prominently and avoid hiding small differences with hardcoded plugs.

Enterprise value measures the value attributable to all capital providers, while equity value belongs only to common shareholders.

• Equity value is the current share price multiplied by diluted shares outstanding.
• Enterprise value adds debt and debt-like claims because an acquirer assumes or refinances them.
• It subtracts cash because excess cash can reduce the effective purchase cost.
• Enterprise value pairs with pre-interest metrics such as revenue and EBITDA, while equity value pairs with net income or EPS.

I start with equity value, add debt and other senior claims, then subtract cash and nonoperating investments.

• A basic bridge is equity value plus total debt plus preferred stock plus noncontrolling interest minus cash.
• Debt-like items can include unfunded pensions, finance leases, or transaction-specific liabilities if the deal definition requires them.
• Nonoperating assets such as unconsolidated investments may be subtracted when their earnings are excluded from the operating metric.
• I would follow the transaction's definitions rather than apply every adjustment mechanically.

Debt raises the cost to acquire the operations, while available excess cash lowers the net cost.

• An acquirer effectively takes responsibility for repaying or refinancing the target's debt.
• Cash acquired with the business can be used to fund part of the purchase price or repay debt.
• Only excess or available cash should be treated this way because some cash is needed to run the business.
• The treatment creates a value for the operating business independent of its financing mix.

Net working capital is operating current assets minus operating current liabilities.

• Typical operating assets include accounts receivable and inventory.
• Typical operating liabilities include accounts payable and accrued operating expenses.
• Cash, debt, and usually short-term investments are excluded because they are financing or nonoperating items.
• The change in net working capital, not the balance itself, enters unlevered free cash flow.

An increase in net working capital means more cash is tied up in operations before it can be distributed to investors.

• Higher receivables mean revenue has been recognized but customers have not yet paid.
• Higher inventory means cash has been spent on goods that have not yet generated sales.
• Higher payables offset the use of cash because suppliers are financing part of the operating cycle.
• Therefore, the increase in net working capital is subtracted in the free cash flow calculation.

Yes, negative net working capital can be healthy when customers pay before the company must pay suppliers.

• Grocery retailers often collect cash immediately while paying suppliers later.
• Subscription businesses may receive annual payments upfront and record deferred revenue.
• In those models, growth can generate operating cash rather than consume it.
• It becomes concerning when the negative balance comes from overdue payables or an inability to meet short-term obligations.

EBITDA is earnings before interest, taxes, depreciation, and amortization, used as a rough measure of operating performance before financing and major noncash charges.

• Starting from EBIT, add depreciation and amortization.
• Starting from net income, add interest, taxes, depreciation, and amortization.
• Because it is before interest, EBITDA can support comparisons across companies with different capital structures.
• It is not cash flow because it ignores capital expenditure, working capital needs, taxes, and interest payments.

EBITDA can overstate cash generation because it excludes several recurring cash requirements.

• A capital-intensive company may need large annual capital expenditures even though depreciation is added back.
• Fast growth can consume cash through receivables and inventory despite rising EBITDA.
• Cash taxes and interest still reduce the cash available to equity holders.
• Two companies with the same EBITDA can therefore have very different free cash flow.

Adjusted EBITDA removes items presented as nonrecurring or nonoperating, but each add-back needs evidence.

• A one-time restructuring charge may be valid if the company is not recording similar charges every year.
• Stock-based compensation is noncash, but it is recurring and dilutive, so I would show its treatment clearly.
• Projected cost savings should be separated from historical results and supported by an implementation plan.
• I would reconcile adjusted EBITDA to reported operating income so every adjustment is traceable.

Unlevered free cash flow is cash generated by operations before debt payments and is available to all capital providers.

• Start with EBIT and apply the tax rate to calculate NOPAT.
• Add back depreciation and amortization because they reduced EBIT without using cash in the period.
• Subtract capital expenditures because they are real investments in operating assets.
• Subtract the increase in net working capital because it represents cash tied up in operations.

A DCF values a company by discounting projected unlevered free cash flow and terminal value to the present.

• Project operating results for a reasonable explicit period, often five years, and calculate annual unlevered free cash flow.
• Estimate WACC using the company's target capital structure and market-based costs of debt and equity.
• Calculate terminal value using either perpetual growth or an exit multiple, then discount all cash flows by WACC.
• Sum the present values to get enterprise value and apply the EV-to-equity bridge to reach implied share price.

WACC is the blended required return of debt and equity investors, weighted by their market values.

• The equity component is cost of equity multiplied by equity as a share of total capital.
• The debt component is pre-tax cost of debt multiplied by one minus the tax rate and debt as a share of total capital.
• The tax adjustment reflects that interest is generally tax deductible.
• WACC discounts unlevered free cash flow because both are measured before payments to debt and equity holders.

Under CAPM, cost of equity equals the risk-free rate plus beta multiplied by the equity risk premium.

• I would use a government bond yield in the same currency as the forecast as the risk-free rate.
• Beta measures the stock's sensitivity to the market and is often derived from comparable companies, then unlevered and relevered.
• The equity risk premium is the expected market return above the risk-free rate.
• A higher beta or equity risk premium raises the discount rate and lowers the DCF value, all else equal.