Financial Statement Analysis Interview Questions

To calculate Return on Equity (ROE), divide net income by average shareholders' equity. Return on Assets (ROA) is calculated by dividing net income by average total assets. Return on Investment (ROI) is calculated by dividing the net profit by the total investment cost. Interpreting these ratios involves assessing the efficiency of the company in utilizing its equity, assets, and investments to generate profit.

The debt-to-equity ratio is calculated by dividing total debt by total equity. It measures a company's financial leverage and indicates how much debt is used to finance the company's assets. A higher ratio suggests higher leverage, which may increase risk but could also offer higher returns. The analysis involves comparing the ratio with industry standards and assessing the company's ability to service its debt.

The DuPont analysis breaks down Return on Equity (ROE) into three components: profit margin, asset turnover, and financial leverage. It helps identify the key drivers of a company's profitability. By analyzing each component, you can assess whether low ROE is due to low margins, inefficient use of assets, or excessive leverage. This analysis provides a deeper understanding of performance beyond the overall ROE figure.

WACC is calculated by multiplying the cost of each capital component (debt and equity) by its proportional weight and summing the results. The formula is: WACC = (E/V * Re) + (D/V * Rd) * (1 - Tc), where E = equity, V = total capital, Re = cost of equity, D = debt, Rd = cost of debt, and Tc = corporate tax rate. WACC is important as it represents the average rate of return a company must earn to satisfy its investors and maintain value.

Contingent liabilities are potential liabilities that may arise depending on the outcome of a future event, such as a lawsuit or warranty claim. In financial analysis, contingent liabilities are disclosed in the notes to the financial statements and, if probable and measurable, are recorded as liabilities. If the likelihood is remote, they are not recognized but still disclosed to provide transparency to investors.

Operating cash flow (OCF) represents the cash generated from the company's core business operations, excluding financing and investing activities. Free cash flow (FCF) is the cash remaining after the company has paid for capital expenditures needed to maintain or expand its asset base. FCF is a key indicator of a company's ability to generate cash for dividends, debt repayment, or reinvestment.

The accounts receivable turnover ratio is calculated by dividing net credit sales by average accounts receivable. It measures how efficiently a company collects its receivables. A higher ratio indicates that the company collects receivables more quickly, improving cash flow. A lower ratio suggests inefficiencies in collections or that credit sales are growing faster than collections.

In vertical analysis, each item in a financial statement is expressed as a percentage of a base amount, such as total revenue or total assets, to evaluate the relative size of each line item. In horizontal analysis, financial data is compared over multiple periods to identify trends and growth patterns. These analyses help assess a company's financial performance, identify areas of improvement, and provide insights into long-term sustainability.

To adjust financial statements for non-recurring events, I would exclude or adjust the impact of these events, such as one-time gains or losses, restructuring costs, or extraordinary items. This helps in providing a clearer picture of a company's ongoing operational performance and profitability. Adjusting for non-recurring events enables a more accurate comparison of financial results across periods and companies.

Goodwill impairment occurs when the carrying value of goodwill exceeds its recoverable amount. This results in a non-cash charge to the income statement, which reduces net income and, consequently, shareholder equity. While it does not affect cash flow directly, it may signal underlying issues in the company’s performance or value, impacting investor perception and potentially leading to a decrease in stock price.