Every concept, endless questions
Each concept is a small financial model. Read how it works, then draw a real interview question from it: forwards, backwards or what-if, with fresh numbers and a worked solution every time.
Forward runs a concept the usual way. Inverse runs it backwards, which is what separates understanding from memorizing.
Accounting
6 conceptsDepreciation through the three statements
Depreciation is a non-cash expense. It reduces pre-tax income, so it reduces taxes actually paid. Net income falls by D×(1−t), but the full D is added back on the cash flow statement, so cash RISES by D×t — the tax shield. Assets fall by D×(1−t) net, and equity falls by the same, so the balance sheet still balances.
Working capital changes and cash flow
Working capital is cash tied up in running the business. Money owed to you (receivables) and goods sitting on shelves (inventory) are cash you have spent but not collected — so when they grow, cash falls. Money you owe suppliers (payables) is the opposite: stretching it is a free loan. Cash flow moves in the exact opposite direction to net working capital, one for one.
Inventory write-down and asset impairment
A write-down or impairment is a non-cash charge: the asset is marked down on the balance sheet and the same amount runs through the income statement as an expense. Whether cash moves at all depends on tax. An inventory write-down is generally deductible, so cash taxes fall and cash actually RISES by the tax shield. A goodwill impairment is usually not deductible, so net income falls by the full charge and cash does not move. Either way the balance sheet balances: the asset falls, cash rises by the shield (if any), and equity falls by the after-tax charge.
Deferred revenue and recognition timing
Cash and revenue arrive at different times. When a customer pays upfront, the company has the cash but has not yet earned it, so it books a liability — deferred revenue — for the service it still owes. Revenue is then recognized evenly as the service is delivered, and the liability unwinds by the same amount. Net income follows revenue, not cash; the only later cash movement is the tax paid on the income as it is recognized.
Capitalize versus expense
Expensing puts the whole cost through the income statement now. Capitalizing parks it on the balance sheet and releases it as depreciation over its useful life. The cash spent is identical; what changes is timing. Capitalizing flatters year-one EBITDA and net income and shows the outlay in investing rather than operating cash flow. Its one real cost is tax: a smaller deduction now means a smaller tax shield now, so year-one cash is lower. Over the full life, total net income and total cash are the same either way.
Deferred tax assets and the valuation allowance
A net operating loss is worth something: it can offset future taxable income. The balance sheet records that worth as a deferred tax asset equal to the loss times the tax rate. When the company later makes money it pays less cash tax than its income statement shows, and the DTA unwinds by the difference. If it may never earn enough to use the loss, it books a valuation allowance — a non-cash charge through tax expense that writes the asset down. And because the asset is loss × rate, a cut in the tax rate shrinks it, which also hits earnings with no cash effect.
Enterprise Value
5 conceptsEquity value to enterprise value bridge
Equity value is what the shareholders own. Enterprise value is what the whole business is worth to everyone who has a claim on it: shareholders, lenders, preferred holders and minority partners. So you start from equity value, add every other claim, and subtract cash — because a buyer inherits the cash and can use it to pay down the debt they also inherit. Moving cash or debt around does not change what the operations are worth; it only changes who owns the claims.
Treasury stock method diluted shares
Options are only dilutive if they are worth exercising — strike below the share price. When holders exercise, they pay the strike price to the company. The treasury stock method assumes the company spends that cash buying back its own shares at the market price, so the true dilution is the options issued less the shares repurchased with the proceeds. Restricted stock units carry no strike, so every unit is a new share. Options with a strike above the price are ignored: nobody exercises at a loss.
Convertible bonds: if-converted versus debt
A convertible bond is debt with an option to swap it for shares at a fixed conversion price. If the shares trade above that price, holders will convert, so you treat the bond as equity: add the conversion shares to the diluted count and leave the bond out of debt. If the shares trade below it, holders keep the bond, so it stays in debt and adds no shares. Never do both — counting the shares AND the debt double-counts the same claim. The two treatments give different enterprise values, and the gap is exactly how far in the money the conversion option is.
Operating leases in enterprise value
Under IFRS 16 (and largely ASC 842) leases sit on the balance sheet as a liability, and the old rent expense is replaced by depreciation and interest — both below EBITDA. So EBITDA goes UP by the rent. That is only a fair comparison if enterprise value goes up too: the lease liability is a debt-like claim on the business and belongs in the bridge. The rule is consistency. Either use the higher EBITDA with an EV that includes lease liabilities, or the lower, pre-lease EBITDA with an EV that excludes them. Mixing them makes the company look cheaper than it is.
What moves enterprise value versus equity value
Enterprise value is the value of the operations. Equity value is the slice of that value, plus the cash, minus the debt, that belongs to shareholders. So a financing decision — raising debt, issuing shares, paying dividends, buying back stock — shuffles claims without changing the operations, and leaves EV alone. Only something that changes the operating assets moves EV. Turning cash into a factory moves EV up by the cash spent; shareholders own the same total, so equity value stays put. Ask two questions of any event: did the operations change, and did cash cross the line to or from shareholders?
DCF & Valuation
6 conceptsUnlevered free cash flow build
Unlevered free cash flow is the cash the operations throw off before anyone is paid for financing it — so it is available to lenders and shareholders alike, and it pairs with WACC in a DCF. Start from operating profit, take tax on that profit as if there were no debt, add back depreciation because it is not cash, then subtract the two things the business must reinvest to keep going: capital expenditure and any cash tied up in working capital. Interest never appears: that is a financing cost, and it is already inside the discount rate.
WACC from capital structure and CAPM
WACC is the blended return the whole capital structure demands. Equity is more expensive than debt because equity holders are paid last; debt is cheaper still after tax because interest is deductible. Weight each by its share of the capital structure at market value, not book. Cost of equity comes from CAPM: the risk-free rate plus beta times the equity risk premium.
Terminal value: perpetuity growth versus exit multiple
The explicit forecast stops after a few years, but the business does not. Terminal value captures everything after that. The perpetuity method grows the final cash flow one more year and capitalises it at WACC minus growth — a small change in either input swings the answer. The exit multiple method applies a market multiple to final-year EBITDA. The two should agree roughly; when they do not, one of your assumptions is out of line with the market, and each method can be inverted to show which.
Mid-year convention and discount factors
A discount factor turns a future dollar into a present one: divide by one plus the rate, once for every year of waiting. The end-of-year convention pretends each year’s cash arrives on 31 December. In reality it arrives all year long, so on average it lands halfway through — the mid-year convention discounts year n by n minus a half. Every cash flow is discounted half a year less, so every present value is higher by the same factor: the square root of one plus the rate.
Levering and unlevering beta
A stock’s beta measures two things at once: how risky the business is, and how much debt sits on top of it. Debt makes equity returns swing harder, so a levered beta is higher than the business alone deserves. To borrow a peer’s beta you first strip out its leverage — unlever — to get the pure business risk, then put your own company’s leverage back on — relever. The tax term is there because interest deductibility softens the effect of debt on equity holders.
Implied share price and WACC sensitivity
A DCF ends in a share price: discount the forecast cash flows and the terminal value to get enterprise value, bridge to equity by taking off debt and adding cash, and divide by the diluted share count. Most of the value sits in the terminal value, and the terminal value is a cash flow divided by WACC minus growth — so a one-point move in WACC swings the price far more than a one-point move in any single year’s cash flow. That is why a DCF is presented as a sensitivity table, and why the market price can be read backwards as the WACC investors are using.
Accretion / Dilution
5 conceptsEPS accretion / dilution in a mixed-consideration deal
Pro forma EPS = (combined net income + after-tax synergies − after-tax financing cost) ÷ (acquirer shares + new shares issued). Cash costs you foregone interest, debt costs you interest expense, stock costs you share count. The deal is accretive when what you buy in earnings outruns what you give up in earnings and shares.
Breakeven P/E and the cash-versus-stock rule
Every form of consideration has a cost expressed as a yield. Paying in stock costs the acquirer its own earnings yield — one over its P/E — because every new share carries a claim on existing earnings. Paying in cash or debt costs the after-tax interest rate. What you buy is the target’s earnings yield at the purchase price — one over the P/E you actually pay, premium included. A deal is accretive when the yield bought exceeds the yield paid. For stock that reduces to: acquirer P/E above the purchase P/E. For cash: purchase P/E below one over the after-tax cost of funds.
Purchase accounting: goodwill and asset step-up
When an acquirer buys a company, it records the target’s assets at fair value, not book. Anything it paid above that fair value is goodwill: the price of relationships, brand and expected synergies that no asset line captures. Writing assets up creates a wrinkle: in a stock purchase the tax authority still sees the old basis, so the higher book value will produce depreciation the company cannot deduct. That future tax cost is booked today as a deferred tax liability — and because the net assets acquired are worth less by that amount, goodwill rises to fill the gap.
Synergy phasing and costs to achieve
Synergies are announced as a run-rate — the annual saving once everything is done — but they arrive gradually, and getting them costs money up front: severance, system migrations, lease exits. So year one usually shows a fraction of the run-rate, offset by most of the one-off costs, and can be a net drag. The market values the run-rate, after tax, at the acquirer’s multiple; the accretion math has to use each year’s phased, after-cost figure instead.
Contribution analysis
In a stock deal both sets of shareholders end up owning the combined company. Contribution analysis asks a simple fairness question: what share of the combined revenue, EBITDA and net income does each side bring, and what share of the combined equity does each side get? If the target contributes a fifth of the earnings but its holders receive a third of the shares, the acquirer is paying up — and the analysis shows exactly what offer value would have matched contribution to ownership. Different metrics give different answers because leverage and margins differ; the spread between them is itself informative.
LBO Basics
5 conceptsLBO returns: MOIC, IRR, and where the return actually comes from
Sponsor equity at entry is enterprise value less debt. At exit, equity is exit enterprise value less whatever debt has not been repaid. Returns come from three places: EBITDA growth, multiple change, and debt paydown. Leverage does not create value — it concentrates whatever value the business creates into a smaller equity check.
Sources and uses
Every buyout starts with a table that must balance. Uses are what the money goes on: buying the equity, repaying the target’s existing debt, and paying the fees. Sources are where it comes from: new debt, sized as a multiple of EBITDA, and whatever is left over comes from the sponsor as equity — sometimes with management rolling part of their stake. The equity check is the plug. Everything the sponsor negotiates, from the purchase price to the leverage the lenders will allow, shows up as a change in that plug.
Paper LBO
A paper LBO is the whole buyout on the back of an envelope. Buy at a multiple with a fixed slug of debt. Each year the business earns EBITDA, pays interest on the debt it has, pays tax on what is left after depreciation, reinvests through capex, and every dollar that remains pays down debt. After five years, sell at a multiple of the bigger EBITDA, repay what debt is left, and the rest is the sponsor’s. Divide by what they put in for the multiple of money; take the fifth root for the IRR.
Debt schedule and the cash sweep
The debt schedule is where an LBO model earns its keep. Each year the business generates cash before debt service; interest comes out first, then the scheduled amortization on the term loan. What remains is excess cash, and the loan agreement says how much of it must be swept to repay the term loan early. Senior debt gets swept first because it is cheapest to the borrower and most protected for the lender; the notes sit untouched until maturity. Every dollar swept this year is interest not paid next year, so the schedule feeds itself.
Entry credit statistics
Lenders judge a buyout with a handful of ratios at closing. Leverage — debt over EBITDA, total and senior — says how many years of earnings it would take to repay them. Interest coverage — EBITDA over interest — says how much earnings can fall before the coupon is in doubt; the version after capex is the honest one. Loan-to-value says how far enterprise value could drop before the lenders are underwater, and the equity cushion is the same thing from the sponsor’s side. Each ratio can be turned around to give the most debt the business can carry under a given floor.
M&A Process
3 conceptsChoosing the process type
A sale process is a trade-off between price, certainty, speed and confidentiality. The more buyers you invite, the more competition and the higher the expected price — but the greater the chance of a leak, the longer it takes, and the more management time it burns. A broad auction invites everyone; a targeted auction invites the few who matter; a negotiated sale talks to one; a dual-track runs a sale alongside an IPO. The banker’s job is to match the process to the buyer universe and to what the seller actually cares about. The funnel from first contact to final bidder is brutal, which is why the number you start with matters.
Advisory fee mechanics
Sell-side advisers are paid mostly on success: a percentage of the enterprise value achieved, payable at closing. The percentage falls as deals get bigger, and engagement letters often add an incentive — a higher rate on value above a hurdle — so that the bank’s interest in the last dollar matches the seller’s. A monthly retainer keeps the bank engaged during the process and is usually credited against the success fee. A fairness opinion is a separate, fixed fee. The right way to read any structure is the effective rate: total fee over the price achieved.
Deal timeline and gating items
A sale runs in sequence up to signing: prepare the materials, market the business, take first-round bids, run diligence and second-round bids, negotiate and sign. Those phases add up. After signing, the conditions to closing run in parallel — antitrust clearance, any shareholder vote, foreign-investment review — so the time to close is set by the slowest of them, not their sum. Whatever sits on that critical path is the gating item, and it is where the deal’s risk lives: every week between signing and closing is a week in which the market, the business or a regulator can change the outcome.