Walk me through the three financial statements: what does each one measure, and over what time frame?
AccountingInterview question
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The answer
- The income statement measures a company's accrual-based profitability over a period, like a quarter or a year, starting from revenue down to net income. It records revenue when earned and expenses when incurred, so net income is not cash.
- The balance sheet is a snapshot of what the company owns and owes at a single point in time, governed by Assets = Liabilities + Shareholders’ Equity. It’s where every dollar of retained earnings from past income statements accumulates.
- The cash flow statement reconciles accrual net income to the actual change in cash over the same period as the income statement. It separates cash into operations, investing, and financing, undoing non-cash items like depreciation and adjusting for working capital to show real cash generation.
- The three link tightly: net income tops the cash flow statement and flows into retained earnings on the balance sheet. Ending cash from the cash flow statement becomes the balance sheet’s cash line. And every change in a non-cash balance sheet account shows up on the cash flow statement, so the statements must move together.
Income statement
| Revenue | 1,000 |
| COGS | (600) |
| Gross profit | 400 |
| SG&A | (180) |
| EBITDA | 220 |
| D&A | (40) |
| EBIT | 180 |
| Interest expense | (20) |
| Pre-tax income | 160 |
| Taxes | (40) |
| Net income | 120 |
Illustrative figures
Also asked as
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- You have the income statement for the year plus the beginning and ending balance sheets, but the cash flow statement is missing. Explain, section by section, how you would reconstruct it.
- A company reports net income of $80, D&A of $25, an increase in accounts receivable of $40, an increase in inventory of $15, an increase in accounts payable of $10, CapEx of $30, a $20 debt issuance, and $12 of dividends. Beginning cash is $35. Calculate CFO, CFI, CFF, and ending cash.
- A company signs a contract in Year 0, delivers the product in Year 1, and collects cash in Year 2. Walk through the impact on all three statements in each of the three years, including the working capital lines.
- On the last day of the year, a company buys equipment for $90 funded entirely with new debt at 6% interest, depreciated straight-line over 5 years, with a 25% tax rate. Quantify the impact on all three statements at purchase and at the end of the following year, and prove the balance sheet balances both times.
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- What is the difference between COGS and SG&A? Give two examples of costs that belong in each for a manufacturing company.
- Walk me through the balance sheet: what are the major sections and how are line items ordered within each?
- Walk me through the cash flow statement: what does each of the three sections capture, and what's the overall purpose of the statement?
- Explain the three hard linkages between the three financial statements.
- Guide: Accounting terms study guide
The rest of this topic
The three statements, linked