There have been a lot of "moral support" threads lately (here, here, here and here if you missed them the first time), so I thought I'd post on skills development (how you can actually "get better").
I'm sure people have their favorites, but these three technical questions are the most common I've seen across banks:
1. Walk me through a DCF
2. My M&A questions (level 1 and 2)
3. Three Statement Capex Question
Since I've gone over the first two in other posts (DCF and M&A), I thought I'd give some advice on another popular question.
Question Three: Three Statement Capex
Assume a company purchases a piece of equipment. Walk me through the effects on the three financial statements for:
1. When the actual purchase is made using (debt / equity) financing
2. When the machine has been used for one full year
Again, as usual, the trick is structuring your thoughts well.
My first piece of advice is flow the three statements together. Too often, I've seen eager candidates jump right into capex, then mention depreciation, then mention interest expense for debt. Because they are shouting out things as they think of them, they are almost 100% guaranteed to miss something. May I respectfully recommend the following flow:
IS --> CFS --> BS
Why? Top to bottom
1. Income Statement: Starts at Revenue, ends at Net Income
2. Cash Flow Statement: Starts at Net Income, ends at Change in Cash
3. Balance Sheet: Starts at Cash and ends at Retained Earnings
If you use this progression, you are systematically less likely to miss something.
Other Hints
- The pure act of purchasing the machine (without having used it) has no effect on income statement because you haven't used it yet. There is no change to CFO. Only CFI (for capex) and CFF (debt or equity raise).
- Pick numbers that are easy (but not too easy) and reasonable (Equipment is worth $100. Interest rate of 8%, tax rate of 30%)
- State your assumptions out loud ("straight line depreciation over 10 years with no salvage value")
- Make sure your balance sheet balances when you're done (say it out loud as you confirm your math) otherwise you're missing something
- PRACTICE
Good luck!
