IB Interview : Level 3 Accounting Questions
Three Statement Impacts
1. If I buy a piece of equipment in cash for $100, how does it impact the three financial statements? (20% tax rate)
There is Zero impact to the Income Statement at the time of the initial purchase.
However, we record ($100) Capital Expenditures in Cash Flows from Investing which results in a ($100) Change in Cash.
The ($100) decrease in Cash lowers the cash account by ($100).
The offsetting entry to balance the Balance Sheet is to increase PP&E by +$100.
2. Walk me through the impact of a $10 increase in PIK Interest across the 3 financial statements? (20% tax rate)
The $10 PIK Interest reduces Taxable Income by $10 which creates a tax credit of $2 ($10 PIK Interest * 20% Tax Rate).
The net impact to Net Income is ($8) which carries to CFO where we add the $10 PIK Interest back which results in a net impact to CFO of +$2, which flows down to a Net Change in Cash of +$2.
The +$2 Cash impact increases the Cash account by +$2.
On the other side of the Balance Sheet, the Debt account increases by the +$10 PIK Interest expense and we deduct the ($8) Net Income impact in Retained earnings to balance the Balance Sheet.
3. We use cash to pay off $100 of Debt at face value. How does that affect the 3 financial statements? (20% tax rate)
Zero impact to the Income Statement from this transaction.
($100) Debt Paydown in Cash Flows from Financing which results in a ($100) Change in Cash.
The ($100) decrease in Cash lowers the cash account by ($100).
The offsetting entry to balance the Balance Sheet is to reduce Debt by ($100).
4. As a business owner do you prefer positive or negative net working capital if you know the business will grow forever?
You would choose the business with Negative Working Capital because it will generate extra cash from the Negative Working Capital as it grows into perpetuity.
5. A Company has negative Net Working Capital (NWC), NWC is proportional to Sales. If the business doubles, what’s the impact to Cash from NWC?
There will be a positive impact to Cash. If a company has Negative Net Working Capital, that means that Current Liabilities are greater than Current Assets.
If both grow proportional to sales, the absolute dollar growth in Current Liabilities will exceed the growth in Current Assets, resulting in an increase in Liability on a net basis, which is a Source of Cash.
The rule of thumb is that if a company has Negative Net Working Capital (and all the underlying components) are proportional to revenue…and revenue grows…it will result in a cash inflow from Net Working Capital…and if the Revenue declines, there will be a cash outflow from Net Working Capital.
Negative Net Working Capital is a tricky concept, but if you can remember this rule of thumb, then you’re in good shape.
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