Accounting and Valuation Prep: Prep Guides and Financial Statements, Lecture notes of Finance

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Interview Prep Meeting Francesca Ventura

Agenda

• Behavioral
• Accounting
• Valuation
• Enterprise value / Equity Value
• DCF
• M&A
• LBO
• Miscellaneous

Other helpful behavioral tips

• Write out an answer to each behavioral question in the

guide

• Think 6 – 10 anecdotes that you can mold into an

answer for a variety of questions

• Practice your story in front of the mirror and record

yourself

• Should 2-2.5 min long (try not to go long, the best interviews

are conversational)

• Research the people you are interviewing with

beforehand

• Listen to their introductions, so you can ask them something

interesting/relevant when comes time for questions

Keep up to Date with News

• Resources
  • Morning Brew
  • Wall Street Journal
  • Bloomberg (Gadfly)
  • CNBC
  • The Economist
• The more you know the better off you will be and easier it will be to have a knowledgeable conversation

Accounting Basics

▪ What are the 3 financial statements? Walk through them / how do they flow together

1. Income Statement
   • Gives a company’s revenue and expenses
   • Bottom line is Net Income for the period
2. Statement of Cash Flows
   • Top line is Net Income
   • Adjusts Net Income for non-cash expenses and working capital changes, then lists cash flow from investing and financing activities
   • Bottom line is company’s net change in cash for the period
3. Balance Sheet
   • Shows the company’s assets, liabilities, and shareholders’ equity
   • Change in cash from statement of cash flows incorporated into cash account in assets
   • Net income is included in retained earnings, a shareholders’ equity account ▪ What are some accounts on each statement? ▪ What is working capital? ▪ What is Net PPE?

Accounting Basics Cont’d

▪ If you were stranded on a desert island and could only pick 1 financial statement to bring with you, what would it be? ▪ Always the statement of cash flows. Cash flows are the best way to analyze a company’s actual performance – income statements and balance sheets use accrual accounting, so they don’t always show the actual health of the company and how much cash it is generating ▪ Cash flows are what you care about when you’re investing ▪ But what if I can bring 2 financial statements with me? ▪ Income Statement and Balance sheet – you can create the cash flow statement from these two, so you’d essentially have all 3 ▪ Note: Need B/S from current period and prior period ▪ What is EBITDA? Why do bankers use it? ▪ Earnings Before Interest, Taxes, Depreciation, and Amortization ▪ Proxy for cash flow ▪ Note: not a perfect proxy because it totally eliminates the cash flow that goes to capital expenditures; this cash outflow (or inflow, if it’s a long-term asset sale) can be sizeable

Advanced Accounting Questions

▪ Some variation on: ▪ If I buy $X of PPE and the tax rate is X%, how does that affect the three statements? ▪ What might change ▪ How do you fund the purchase of PPE? Cash/Debt? Equity? Both? ▪ What if you increase different asset accounts? ▪ What happens if the PPE breaks? ▪ What happens to the financial statements 1 or 2 years after the original question? ▪ Do you need to include depreciation? Interest expense? ▪ Organize your thinking and prepare answers to the basic questions

Framework for Answers

▪ Hard question? Think through it (and answer it) this way ▪ Keep thoughts consistent and organized, which is good for both you and the interviewer ▪ One statement at a time: Income Statement Cash Flow Statement Balance Sheet P Does the Balance Sheet Balance? ALWAYS check! Net Income (^) Cash

Cash Flow Statement

▪ How has the top line (net income) changed? ▪ Think through each of the 3 sections ▪ If one section hasn’t changed, simply say “no changes in…” and move on ▪ Will often follow up with why did you make changes in cash flows? ▪ Depreciation is non-cash but it was deducted from net income and reduced taxes ▪ Interest expense not added back because it IS a cash expense Income Statement Cash Flow Statement Balance Sheet Net Income (^) Change in Cash

Balance Sheet

▪ How did cash balance change? Start with change in cash from CF statement ▪ Talk through the rest of the asset side ▪ Did current assets or PPE change (if you added depreciation expense, it did)? ▪ Liabilities + Shareholders’ Equity side ▪ Net Income will increase or decrease Retained Earnings ▪ Remember that this is the after-tax number ▪ Interest Expense is an expense , won’t change balance sheet ▪ Does it balance? Always check, and let them know you know it balances Income Statement Cash Flow Statement Balance Sheet Net Income (^) Cash

Sample Accounting Questions

▪ What are the 3 financial statements, and how do they tie together? ▪ Why is the statement of cash flows important? ▪ Why isn’t EBITDA a good proxy for cash flows? ▪ If I incur $10 of depreciation expense, how does that affect the 3 financial statements? ▪ If I paid cash for $100 of PPE on December 31, how does that affect the 3 financial statements now? Assume that the acquisition is financed with debt ▪ Assume that the acquisition is financed with debt, which includes a 10% interest rate, and that the PPE is amortized at 10% per year ▪ How does that affect the 3 financial statements one year later? ▪ If I use cash to buy $100 of inventory, how does that affect the 3 financial statements?

Valuation

▪ What are the ways to value a company? When do you use them? ▪ Here’s where you can get conceptual, sometimes strange versions of the question (i.e. how would you value Facebook? An apple tree?) ▪ When do bankers use valuation? ▪ Pitch books and presentations, buy-side and sell-side acquisition advising, LBOs, defense analyses ▪ Give the company an idea of how much outside buyers will pay for it ▪ Know the benefits and drawbacks to each methodology ▪ If you can do that, you can pretty much do all of this section

Importance of DCF

▪ After accounting questions, DCF-related questions are the most common: ▪ When you would use a DCF ▪ Walk me through a DCF ▪ How to derive free cash flows ▪ Calculating the discount rate (WACC) ▪ Levered / unlevered Beta

• Why would you do a DCF? ▪ Discounted cash flow analysis is one method of valuation ▪ Uses future free cash flows and discounts them at the WACC to arrive at a present value ▪ Estimate of the cash you will receive in the future and how much you’d pay for that right now ▪ Intrinsic value, not reliant upon market sentiment

Walk Me Through a DCF

▪ The stereotypical technical question ▪ If the interviewer doesn’t do this often, you will get this question ▪ Memorize the steps, formulas & how you’d say it (like your resume walk) ▪ Sample Answer ▪ The steps:

1. Project free cash flows for a given number of years
   • 5 – 10 years (any more and your accuracy keeps getting worse)
   • FCF = EBIT(1 - T) + D&A - Capex – ∆WC
   • Unlevered Free Cash Flow – the value independent of the debt (capital structure) because it does not include interest
2. Find the terminal value, or the value of the company beyond the projected years in 1 of 2 ways