Interview / Accounting

Accounting

Accounting interview questions

The three statements, how they link, and the depreciation walk-through that every banking interview eventually arrives at.

Accounting is the foundation layer. If you cannot link the three statements, every valuation answer you give afterwards rests on sand — and interviewers know it, which is why this comes first.

Walk me through the three financial statements

The answer

“The income statement shows profitability over a period: revenue down through costs to net income.

The balance sheet is a snapshot at a point in time: assets on one side, liabilities and equity on the other, and it must balance.

The cash flow statement reconciles net income to the actual cash that moved, split into operating, investing and financing activities.

The reason all three exist is that profit and cash are not the same thing. A company can be profitable and run out of money.”

How do the three statements link?

This is the follow-up, and it is the one that separates people.

  • Net income from the bottom of the income statement is the top line of the cash flow statement, and it flows into retained earnings on the balance sheet.
  • The cash balance at the bottom of the cash flow statement is the cash line at the top of the balance sheet.
  • Non-cash charges like depreciation reduce income-statement profit but are added back on the cash flow statement, because no cash left the business. The same depreciation reduces the carrying value of PP&E on the balance sheet.

If depreciation increases by $10, what happens?

The single most-asked accounting question in banking. Assume a 25% tax rate and work through all three statements, out loud, in this order.

The walk-through

Income statement: operating income falls by $10. At a 25% tax rate, net income falls by $7.50.

Cash flow statement: start with net income down $7.50, then add back the $10 of depreciation because it is non-cash. Net effect: cash increases by $2.50 — the tax saved.

Balance sheet: cash is up $2.50, PP&E is down $10, so assets fall by $7.50. On the other side, retained earnings fall by $7.50 through net income. It balances.”

The insight worth stating explicitly: a larger non-cash charge increases cash, because it reduces the tax bill without costing anything. That is the whole point of the question.

Other questions that come up constantly

Which statement would you pick if you could only have one?

The cash flow statement. It is the hardest to manipulate, and it tells you whether the business actually generates money. A defensible alternative is the balance sheet — two balance sheets let you derive much of the rest — but have a reason ready either way.

What is working capital and why does a change in it matter?

Current assets minus current liabilities. An increase in working capital — more inventory, more receivables — consumes cash, because you have paid for something you have not yet been paid for. Fast-growing companies often have strong profits and negative cash flow for exactly this reason.

How can a profitable company go bankrupt?

By running out of cash. Profit is an accounting measure that recognises revenue when earned, not when collected. A business with long receivables, heavy inventory or a large debt repayment falling due can be comfortably profitable on paper and still fail to meet an obligation. This is why the cash flow statement exists.

What is the difference between accrual and cash accounting?

Accrual recognises revenue when it is earned and costs when they are incurred, regardless of when cash moves. Cash accounting records only cash in and out. Public companies use accrual because it matches revenue to the costs that produced it — which is also precisely why the cash flow statement is needed to translate back.

Now answer them yourself

Real questions from the Basis curriculum, with the explanation after each one. No account needed.

Common follow-ups

What are the three financial statements?
The income statement (profitability over a period), the balance sheet (a snapshot of assets, liabilities and equity at a point in time), and the cash flow statement (which reconciles net income to the cash that actually moved, split into operating, investing and financing).
How do the three financial statements link together?
Net income flows from the income statement to the top of the cash flow statement and into retained earnings on the balance sheet. The closing cash balance on the cash flow statement becomes the cash line on the balance sheet. Non-cash charges such as depreciation reduce net income but are added back on the cash flow statement, and reduce the asset's carrying value on the balance sheet.
If depreciation increases by $10, what happens to the three statements?
At a 25% tax rate: operating income falls $10 and net income falls $7.50. On the cash flow statement, net income is down $7.50 but the $10 of depreciation is added back, so cash rises $2.50. On the balance sheet, cash is up $2.50 and PP&E is down $10, so assets fall $7.50, matched by a $7.50 fall in retained earnings. The net effect on cash is positive because the charge reduces tax without costing cash.
Which financial statement would you choose if you could only have one?
Most answers go to the cash flow statement: it is the hardest to manipulate and shows whether the business genuinely generates money. The balance sheet is a defensible alternative, since comparing two balance sheets lets you reconstruct much of the other statements. What matters is that you can justify the choice.
How can a profitable company go bankrupt?
By running out of cash. Accrual accounting recognises revenue when earned rather than collected, so a company with slow receivables, heavy inventory investment or a large debt maturity can report profits and still be unable to pay an obligation when it falls due.

Drill this properly

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Valuation Valuation interview questions Accounting What is a balance sheet? Accounting The cash flow statement