IB Interview Questions: Level 2 Accounting Questions Part - 2

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Cash and Working Capital Dynamics

1. Why isn’t cash part of Working Capital?

Cash is a ‘Non-Operating Asset’ as opposed to items like Inventory, Accounts Receivable, etc. which are ‘Operating Assets.’

In plain English, Cash is an output of the business and is not employed in the business’ operations.

By comparison, an item like Accounts Receivable is directly employed in the business.

2. How do you calculate Unlevered Free Cash Flow?

The formula for Unlevered Free Cash Flow is: EBIT – Tax + D&A – CapEx +/- Changes in Net Working Capital.

The formula can also be presented as: EBIT * (1 – T) + D&A – CapEx +/- Changes in NWC

As the owner of a business, how would you explain: EBIT – Tax + D&A – CapEx +/- Changes in Net Working Capital…in Plain English?

This is my after-tax profit (in cash) after taking into account reinvestment back into the business.

3. What is the difference between EBITDA and (Unlevered) Free Cash Flow?

EBITDA reflects EBIT (Profit) + D&A (Non-Cash Items) but leaves out Capital Intensity (CapEx + NWC) and Taxes.

Unlevered Free Cash Flow (UFCF) incorporates all three of those items. This is why EBITDA is called a ‘Cash Flow Proxy.’

Note that if the interviewer doesn’t specify Levered vs Unlevered Free Cash Flow, you should probably assume they are referring to Unlevered Free Cash Flow.

4. Is an increase/decrease in an Asset or Liability a Source or Use of Cash?

An increase in an Asset is a Use of Cash, whereas a Decrease in an Asset is a Source of Cash.

An increase in a Liability is a Source of Cash, whereas a Decrease in a Liability is a Use of Cash.

This question can come in the format shown above as well as, ‘Would an increase/decrease in [Balance Sheet Account] create a Source or Use of Cash?’

Either way, the answer follows the rules listed above for both Assets and Liabilities.

5. What is Capital Intensity and how does Working Capital play a role in a business?

Capital Intensity is the combination of Capital Expenditures and Net Working Capital.

In Plain English, these two items simply represent the reinvestments needed to maintain (and grow) the business.

6. One business outsources manufacturing and another doesn’t, which has lower Capital Intensity?

The business that outsources has lower Capital Intensity. Capital Intensity is a function of Capital Expenditures and Net Working Capital. In the case of this question, a business that outsources has lower Capital Expenditures and thus lower Capital Intensity.



7. What is Negative Net Working Capital?

First, Net Working Capital (NWC) is Current Assets (Excl Cash) – Current Liabilities. Negative Net Working Capital comes about when Current Liabilities are greater than Current Assets (excl Cash).

Negative NWC results from suppliers (Inventory), service providers such as landlords, employees, etc. (Accrued Liabilities), or customers (Deferred Revenue) that lend us money in advance of either Revenue being earned or an Expense being incurred.

8. How can a company show positive net income but have zero cash flow?

The most likely reason for this would be that we recorded revenue in the Income Statement but hadn’t collected cash yet.

This is because accounting reflects the underlying economic substance of transactions and not cash flows.

9. How could we make significant operating cash flow and show zero net income?

If a business generated significant cash flow from selling subscriptions (i.e. Deferred Revenue), it would generate significant Cash Flow.

However, the earnings from the subscriptions would not be recorded until the service underlying the subscription had been earned.

As such, at the outset, the company would show zero Net Income.

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