Finance Basics For Interview

Finance is a broad field, but for an interview, focusing on core concepts is crucial. Here’s a breakdown of finance basics, covering key terms and principles:

Key Financial Statements

Understanding financial statements is fundamental. Three main statements exist:

• Income Statement: Shows a company’s financial performance over a period of time. Key components include revenue, cost of goods sold (COGS), gross profit, operating expenses, operating income (EBIT), interest expense, taxes, and net income (profit). The basic equation is: Revenue – Expenses = Net Income.
• Balance Sheet: Provides a snapshot of a company’s assets, liabilities, and equity at a specific point in time. The fundamental accounting equation is: Assets = Liabilities + Equity. Assets represent what a company owns (cash, accounts receivable, property, plant, and equipment – PP&E). Liabilities represent what a company owes to others (accounts payable, loans, deferred revenue). Equity represents the owners’ stake in the company (retained earnings, common stock).
• Cash Flow Statement: Tracks the movement of cash both into and out of a company over a period of time. It’s divided into three sections: operating activities (cash generated from core business operations), investing activities (purchase and sale of long-term assets like PP&E), and financing activities (raising capital through debt or equity). It reconciles net income to actual cash generated.

Time Value of Money

This concept is a cornerstone of finance. It states that money available today is worth more than the same amount of money in the future due to its potential earning capacity.

• Present Value (PV): The current worth of a future sum of money or stream of cash flows, given a specified rate of return.
• Future Value (FV): The value of an asset or investment at a specified date in the future, based on an assumed rate of growth.
• Discount Rate: Used to calculate the present value. It reflects the opportunity cost of capital and the risk associated with receiving the future cash flow.

Valuation

Determining the worth of an asset or company is crucial. Common valuation methods include:

• Discounted Cash Flow (DCF) Analysis: Projects future cash flows and discounts them back to their present value using a discount rate. This is considered a fundamental approach to valuation.
• Comparable Company Analysis (Comps): Compares a company’s financial ratios (e.g., P/E, EV/EBITDA) to those of similar publicly traded companies to derive a valuation.
• Precedent Transactions: Examines past mergers and acquisitions (M&A) transactions involving similar companies to determine what buyers have historically been willing to pay.

Financial Ratios

Ratios provide insights into a company’s financial health and performance. Key categories include:

• Liquidity Ratios: Measure a company’s ability to meet its short-term obligations (e.g., current ratio, quick ratio).
• Profitability Ratios: Measure a company’s ability to generate profits (e.g., gross profit margin, net profit margin, return on equity – ROE).
• Solvency Ratios: Measure a company’s ability to meet its long-term obligations (e.g., debt-to-equity ratio, debt-to-asset ratio).
• Efficiency Ratios: Measure how efficiently a company is using its assets to generate revenue (e.g., inventory turnover, accounts receivable turnover).

Risk and Return

A fundamental principle: higher risk generally implies a higher potential return, and vice-versa. Different types of risk exist:

• Systematic Risk (Market Risk): Risk inherent to the entire market that cannot be diversified away (e.g., interest rate changes, economic recessions).
• Unsystematic Risk (Specific Risk): Risk specific to a particular company or industry that can be reduced through diversification (e.g., product recall, management changes).

Capital Structure

The mix of debt and equity a company uses to finance its operations. Optimizing capital structure is key to maximizing shareholder value. Debt is generally cheaper than equity (due to tax shields), but it also increases financial risk.

Being able to define these concepts and explain their importance will significantly strengthen your performance in a finance interview. Remember to practice applying these concepts to real-world scenarios.