Finance Concepts

Question & Answers

 Explain Financial Modeling
Financial modeling is a quantitative analysis
commonly used either for asset pricing or general
corporate finance.
Essentially, hypothetical variables are used in a
formula to determine the likely impact on market
behavior, profitability or economic conditions.
Could be used to determine effect on jet fuel cost
on airline as a result of 5% annual rise in the cost
of crude oil over next 5 to 7 years.
 Walk me through a cash flow
statement
Start with net income, go line by line through major
adjustments (depreciation, changes in working capital and
deferred taxes) to arrive at cash flows from operating
activities.
Mention capital expenditures, asset sales, purchase of
intangible assets, and purchase/sale of investment securities
to arrive at cash flow from investing activities.
Mention repurchase/issuance of debt and equity and paying
out dividends to arrive at cash flow from financing activities.
Adding cash flows from operations, cash flows from
investments, and cash flows from financing gets you to total
change of cash.
Beginning-of-period cash balance plus change in cash allows
you to arrive at end-of-period cash balance.
 Difference between costing and cost
accounting
Costing is a process of ascertaining cost
whereas cost accounting is a process of
recording various costs in a systematic manner
in order to ascertain total cost.
Opportunity Cost?
Differential Cost?
 Is it possible for a company to show positive cash
flows but be in grave trouble?

Absolutely. Two examples involve

unsustainable improvements in working
capital (a company is selling off inventory and
delaying payables),
Another example involves lack of revenues
going forward in the pipeline.
 Describe a financial report you have
analyzed recently
Demonstrate your ability to evaluate data.
Mention the analysis you have done in your
corporate finance paper.
Ratio, Cash Flow, Decision tree etc.
 What is working capital
Working capital is defined as current assets
minus current liabilities;
It tells the financial statement user how much
cash is tied up in the business through items
such as receivables and inventories.
How much cash is going to be needed to pay
off short term obligations in the next 12
months.
 What is financial forecasting

Forecasting of cost centre expenses.

Monitoring expenditure against forecasts.
Profit forecasting.
Budgeting (Different Budgets)
 What is composite cost of capital?
Explain the process to compute it.
Also known as weighted average cost of
capital.
Tells about component costs of common
stock, preferred stock and debt.
Each of these component is given a weight
according to their proportion in the total
capital.
Weights summed together.
 Why are increases in accounts receivable a cash
reduction on the cash flow statement?

Since our cash flow statement starts with net

income.
An increase in accounts receivable is an
adjustment to net income to reflect the fact
that the company never actually received
those funds.
 What is Capital Structure?
The capital structure is how a firm finances its overall
operations and growth by using different sources of
funds.
Debt comes in the form of bond issues or long-term
notes payable, while equity is classified as common
stock, preferred stock or retained earnings.
Short-term such as working capital requirements is also
considered to be part of the capital structure.
 Financial Vs Operational Risk
Financial risk refers to a company's ability to manage its
debt and financial leverage,
While operational risk refers to the company's ability to
generate sufficient revenue to cover its operational
expenses.
An alternate way of viewing the difference is to see
financial risk as the risk that a company may default on its
debt payments,
And Operational risk as the risk that the company will be
unable to function as a profitable enterprise.
 What is Goodwill
Goodwill is an asset that captures excess of the
purchase price over fair market value of an acquired
business.
Lets walk through the following example: Acquirer
buys Target for $500m in cash.
Target has 1 asset: PPE with book value of $100, debt
of $50m, and equity of $50m = book value (A-L) of
$50m.
Fair Value = Book Value + Equity
Goodwill = Purchase Price Fair Value
 I buy a piece of equipment, walk me through its
impact on the 3 financial statements.

Initially there is no impact on income

statement.
Initially there is no impact on Balance Sheet
also.
Cash outflow in cash flow statement.
Later Depreciation Reduces income
Reduces value of asset added back in cash
flow statement.
 How is income statement linked to
balance sheet?
Net Income flows into retained earnings.
 What is deferred tax liability and why
might one be created?
Deferred tax liability is a tax expense amount reported on a
companys income statement that is not actually paid to the
Govt. in that time period, but is expected to be paid in the
future.
It arises because when a company actually pays less in taxes
to the Govt. than they show as an expense on their income
statement in a reporting period.
Differences in depreciation expense between book reporting
(GAAP) and Govt. reporting can lead to differences in income
between the two, which ultimately leads to differences in tax
expense reported in the financial statements and taxes
payable to the Govt.
What is a deferred tax asset and why
might one be created?
Deferred tax asset arises when a company
actually pays more in taxes to the Govt. than
they show as an expense on their income
statement in a reporting period.
Differences in revenue recognition, expense
recognition, and net operating losses (NOLs)
can create deferred tax assets.
 Questions to prepare yourself
Describe the finance functions within a company and
where you see yourself fitting.
Whats a Price/Earning (P/E) ratio and how do you use it?
What if 2 companies have the same value of P/E ratios,
which company does you think is better?
How would you explain net present value to non-finance
major?
What major factors drive mergers and acquisitions?
What are the significant profile responsibilities of a finance
analyst?
 Questions to prepare yourself
What does it mean when cash flow from
operations on a companys cash flow statement is
negative? Is this bad news? If so, is it dangerous?
Suppose that you constructed a pro forma
balance sheet for a company and the estimate for
external funding required was negative. How
would you interpret this result?
How will a decrease in financial leverage affect a
companys cost of equity capital, if at all?
 Questions to prepare yourself
If you want to assess the health of a company
and you could choose between looking at 3 years
of income statements or 3 years of balance
sheets, which would you choose and why?
What could a company do with excess cash on
the balance sheet?
What could a company do with excess cash on
the balance sheet?
Whats the difference between IRR, NPV and
Payback?
 Questions to prepare yourself
Lets say that I have a bond with a 5% coupon. What
happens to the market price when the prevailing
interest rates rise to 8%? How are the coupons
affected?
Which corporate bond would have a higher coupon, an
AAA or a BBB?
What are the annual payments received by the owner
of a five year zero coupon bonds?
Would you rather have Rs. 1 crore today or Re. 1 a day
for the rest of your life? How would you go about
valuing this amount?