Investment Banking · Topic lesson

Accounting

The three statements and how every change moves through them: depreciation, capitalizing, write-downs, working capital, deferred revenue and deferred tax.

6 chapters About 66 minutes0 of 6 complete

Start chapter 1

Almost every investment banking interview starts with accounting, because every model you will build is three financial statements linked together. The questions nearly all have the same shape: something changes; walk me through what happens. Learn that shape once and every variation becomes solvable.

The income statement shows performance over a period: revenue, less expenses, down to net income. It records revenue when it is earned and costs when they are incurred, not when cash moves.
The balance sheet is a snapshot at one moment: what the company owns (assets) and who has a claim on it (liabilities and equity). Assets always equal liabilities plus equity.
The cash flow statement explains how cash changed over the period. It starts from net income, adjusts for everything that was not cash, then adds investing and financing.

The links are what interviewers test. Net income flows to the top of the cash flow statement and into retained earnings on the balance sheet. The change in cash at the bottom of the cash flow statement becomes the cash line on the balance sheet. Non-cash items and working capital are the adjustments in between.

The rule that solves every question

Walk the statements in the same order every time: income statement, cash flow statement, balance sheet. Finish by checking that assets and liabilities plus equity moved by the same amount. If they did not, a line is missing.

How any change moves through the statements

The order to walk every question in. Each step points to the chapters that practice it.

1
Start on the income statement
Every change begins as revenue or expense: pre-tax income, then tax, then net income.
Chapter 1
2
Adjust to cash
Add back charges that used no cash; take off cash tied up in working capital.
Chapter 1 Chapter 4
3
Decide where costs land
Expense now, capitalize and depreciate, or write the asset down later.
Chapter 2 Chapter 3
4
Match cash to earning
Customers who pay early create a liability until the work is done.
Chapter 5
5
Balance the balance sheet
Cash, the asset or liability, and retained earnings move together; tax timing creates deferred tax.
Chapter 6

Chapters

Depreciation through the three statements

10 min

The walk-through almost every interview starts with, and why an expense can raise cash.

Walk a change in depreciation through all three statements, in order
Explain why cash rises by depreciation × tax rate
Show that the balance sheet still balances
Work back from the change in cash to the depreciation that caused it

Capitalize versus expense

12 min

The same check, two very different-looking years: where a cost lands and why it matters.

Compare the year-one EBITDA, net income and cash of expensing and capitalizing
Explain why capitalizing flatters earnings but costs cash tax in year one
Show that lifetime net income is the same either way
Work back from the earnings gap to the size of the cost

Write-downs and impairments

10 min

Marking an asset down: a non-cash charge whose cash effect depends entirely on tax.

Walk an inventory write-down through the three statements
Explain why a goodwill impairment moves no cash at all
Work out the size of a write-down from the change in cash
Say what a write-down tells you about the business

Working capital and cash flow

12 min

Why a growing, profitable business can run short of cash: money tied up in receivables and inventory.

Turn changes in DSO, inventory days and DPO into dollars
Calculate the change in net working capital and its effect on cash flow
Explain why working capital never touches net income
Work back from a cash impact to the change in supplier payment terms

Deferred revenue

10 min

Paid now, earned later: the liability that turns into revenue as the work is delivered.

Record an upfront payment on all three statements
Calculate revenue recognized and deferred revenue remaining after any number of months
Explain why cash runs ahead of net income
Work out how far into a contract a company is from its balance sheet

Deferred tax assets and losses carried forward

12 min

When losses today cut tax tomorrow: the asset, how it unwinds, and when to write it down.

Size a deferred tax asset from net operating losses
Separate book tax expense from cash tax paid when losses are used
Walk a valuation allowance through the statements
Work out how much loss was used from the gap between book tax and cash tax