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Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
What is the primary purpose of US GAAP? - ansIn the US, the Securities and Exchange Commission ("SEC") authorizes the Financial Accounting Standards Board ("FASB") to determine the set of accounting rules followed by publicly traded companies. Under FASB, financial statements are required to be prepared in accordance with US Generally Accepted Accounting Principles ("US GAAP"). Through the standardization of financial reporting and ensuring all financials are presented on a fair, consistent basis - the interests of investors and lenders are protected. What are the main sections of a 10-K? - ansIn a 10-K, you'll find the three core financial statements, which are the income statement, cash flow statement, and balance sheet. There'll also be a statement of shareholders' equity, a statement of comprehensive income, and supplementary data and disclosures to accompany the financials. Business Overview: Overview of the company's business divisions, strategy, product or service offerings, seasonality, geographical footprint, and key risks. Management's Discussion & Analysis ("MD&A"): Commentary and summarized analysis of the company's fiscal year result from the perspective of the management team. Financial Statements: The "Core 3": Income Statement, Balance Sheet, Cash Flow Statement The "Other 2": Statement of Comprehensive Income, Statement of Shareholders' Equity What is the difference between the 10-K and 10-Q? - ans10-K: A 10-K is the annual report required to be filed with the SEC for any public company in the U.S. The report is comprehensive and includes a full overview of the business operations, commentary on recent performance by management, risk factors, disclosures on changes in accounting policies - and most importantly, the three core financial statements with supplementary data. 10 - Q: A 10-Q refers to the quarterly report required to be filed with the SEC. Compared to the 10-K, this report is far more condensed in length and depth, with the focus being on the quarterly financials with brief sections for MD&A and supplementary disclosures. Additional Differences: A few more differences are 10-Ks are required to be audited by an independent accounting firm, but 10-Qs are only reviewed by CPAs and left unaudited. 10- Ks must also be filed ~60-90 days after the fiscal year ends, whereas 10-Qs must be submitted ~40-45 days after the quarter ends. Walk me through the three financial statements. - ansIncome Statement ("IS"): The income statement shows a company's profitability over a specified period, typically quarterly and
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
annually. The beginning line item is revenue and upon deducting various costs and expenses, the ending line item is net income. Balance Sheet ("BS"): The balance sheet is a snapshot of a company's resources (assets) and sources of funding (liabilities and shareholders' equity) at a specific point in time, such as the end of a quarter or fiscal year. Cash Flow Statement ("CFS"): Under the indirect approach, the starting line item is net income, which will be adjusted for non-cash items such as D&A and changes in working capital to arrive at cash from operations. Cash from investing and financing activities are then added to cash from operations to arrive at the net change in cash, which represents the actual cash inflows/(outflows) in a given period. Walk me through the income statement. - ansThe income statement shows a company's accrual-based profitability over a specified time period and facilitates the analysis of its historical growth and operational performance. The table below lists the major income and expense components of the income statement: Net Revenue (or Sales): The income statement begins with revenue (often called the "top line"), which represents the total value of all sales of goods and delivery of services throughout a specified period. Less: Cost of Goods Sold: COGS represents the costs directly tied to producing revenue, such as the costs of materials and direct labor. Gross Profit: Revenues - Cost of Goods Sold = Gross Profit Less: Research & Development ("R&D"): R&D refers to developing new products or procedures to improve their existing product/service offering mix. EBITDA: Gross Profit - SG&A - R&D = EBITDA. EBITDA stands for: Earnings Before Interest, Taxes, Depreciation & Amortization. Less: Depreciation & Amortization ("D&A"): D&A is a non-cash expense that estimates the annual reduction in the value of fixed and intangible assets Operating Income ("EBIT"): EBITDA - D&A = Operating Income (or EBIT) EBIT stands for: Earnings Before Interest and Taxes.
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
Equity: Equity is the capital invested in the business and represents the internal sources of capital that helped fund its assets. The providers of capital could range from being self- funded to outside institutional investors. In addition, the accumulated net profits over time will be shown here as "Retained Earnings." What are the typical line items you might find on the balance sheet? - ansAssets Section Current Assets (Listed in Order of Liquidity) Cash & Cash Equivalents: This line item includes cash itself and highly liquid, cash-like investments, such as commercial paper and short-term government bonds. Marketable Securities: Marketable securities are short-term debt or equity securities held by the company that can be liquidated to cash relatively quickly. Accounts Receivable: A/R refers to payments owed to a business by its customers for products and services already delivered to them (i.e., an "IOU" from the customer). Inventories: Prepaid expenses are payments made in advance for goods or services expected to be provided on a later date, such as utilities, insurance, and rent. Non-Current Assets Property, Plant & Equipment ("PP&E"): Fixed assets such as land, buildings, vehicles, and machinery used to manufacture or provide the company's services and products. Intangible Assets: Intangible assets are non-physical, acquired assets such as patents, trademarks, and intellectual property ("IP"). Goodwill: An intangible asset created to capture the excess of the purchase price over the fair market value ("FMV") of an acquired asset. Liabilities Section Current Liabilities (Listed in Order of Liquidity) Accounts Payable: A/P represents unpaid bills to suppliers and vendors for services/products already received but were paid for on credit.
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
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Latest Updated Exam Study Guide 2025/
Accrued Expenses: Accrued expenses are incurred expenses such as employee compensation or utilities that have not been paid, often due to the invoice not being received. Short-Term Debt: Debt payments coming due within twelve months, with the current portion of long-term debt also included. Non-Current Liabilities Deferred Revenue: Unearned revenue received in advance for goods or services not yet delivered to the customer (can be either current or non Walk me through the cash flow statement. - ansThere are two methods by which cash flow statements are organized: Direct and Indirect. The more common approach is the indirect method, whereby the cash flow statement is broken out into three sections:
- Cash from Operations: The cash from operations section starts with net income and adds back non-cash expenses such as depreciation & amortization and stock-based compensation, and then makes adjustments for changes in working capital.
- Cash from Investing: Next, the cash from investing section accounts for capital expenditures (typically the largest outflow), followed by any business acquisitions or divestitures.
- Cash from Financing: In the third section, cash from financing shows the net cash impact of raising capital from issuances of equity or debt, net of cash used for share repurchases, and repayments of debt. The cash outflows from the payout of dividends to shareholders will be reflected here as well. Together, the sum of the three sections will be the net change in cash for the period. This figure will then be added to the beginning-of-period cash balance to arrive at the ending cash balance. How are the three financial statements connected? - ansIS ↔ CFS: The cash flow statement is connected to the income statement through net income, as net income is the starting line on the cash flow statement. CFS ↔ BS: Next, the cash flow statement is linked to the balance sheet because it tracks the changes in the balance sheet's working capital (current assets and liabilities). The impact from capital expenditures (PP&E), debt or equity issuances, and share buybacks (treasury
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
Why is the income statement insufficient to assess the liquidity of a company? - ansThe income statement can be misleading in the portrayal of a company's health from a liquidity and solvency standpoint. For example, a company can consistently show positive net income yet struggle to collect sales made on credit. The company's inability to retrieve payments from customers would not be reflected on its income statement. Financial reporting under accrual accounting is also imperfect in the sense that it often relies on management discretion. This "wiggle room" for managerial discretion in reporting decisions increases the risk of earnings management and the misleading depiction of a company's actual operational performance. The solution to the shortcomings of the income statement is the cash flow statement, which reconciles net income based on the real cash inflows/(outflows) to understand the true cash impact from operations, investing, and financing activities during the period. What are some discretionary management decisions that could inflate earnings? - ansUsing excess useful life assumptions for new capital expenditures to reduce the annual depreciation Switching from LIFO to FIFO if inventory costs are expected to increase, resulting in higher net income Refusing to write-down impaired assets to avoid the impairment loss, which would reduce net income Changing policies for costs to be capitalized rather than expensed (e.g., capitalized software costs) Repurchasing shares to decrease its share count and artificially increase earnings per share ("EPS") Deferral of capex or R&D to the next period to show more profitability and cash flow in the current period More aggressive revenue recognition policies in which the obligations of the buyer become less stringent Tell me about the revenue recognition and matching principle used in accrual accounting. - ansRevenue Recognition Principle: Revenue is recorded in the same period the good or
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
service was delivered (and therefore "earned"), whether or not cash was collected from the customer. Matching Principle: The expenses associated with the production/delivery of a good or service must be recorded in the same period as when the revenue was earned. How does accrual accounting differ from cash-basis accounting? - ansAccrual Accounting: For accrual accounting, revenue recognition is based on when it's earned, and the expenses associated with that revenue are incurred in the same period. Cash-Basis Accounting: Under cash-basis accounting, revenues and expenses are recognized once cash is received or spent, regardless of whether the product or service was delivered to the customer. What is the difference between cost of goods sold and operating expenses? - ansCost of Goods Sold: COGS represents the direct costs associated with the production of the goods sold or the delivery of services to generate revenue. Examples include direct material and labor costs. Operating Expenses: Operating expenses such as SG&A and R&D are not directly associated with the production of goods or services offered. Often called indirect costs, examples include rent, payroll, wages, commissions, meal and travel expenses, advertising, and marketing expenses. When do you capitalize vs. expense items under accrual accounting? - ansThe factor that determines whether an item gets capitalized as an asset or gets expensed in the period incurred is its useful life (i.e., estimated timing of benefits). Capitalized: Expenditures on fixed and intangible assets expected to benefit the firm for more than one year need to be capitalized and expensed over time. For example, PP&E such as a building can provide benefits for 15+ years and is therefore depreciated over its useful life. Expensed: In contrast, when the benefits received are short-term, the related expenses should be incurred in the same period. For example, inventory cycles out fairly quickly within a year and employee wages should be expensed when the employee's services were provided. If depreciation is a non-cash expense, how does it affect net income? - ansWhile depreciation is treated as non-cash and an add-back on the cash flow statement, the expense is tax- deductible and reduces the tax burden. The actual cash outflow for the initial purchase of PP&E has already occurred, so the annual depreciation is the non-cash allocation of the initial outlay at purchase. Do companies prefer straight-line or accelerated depreciation? - ansFor GAAP reporting purposes, most companies prefer straight-line depreciation because lower depreciation will be
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
million. Except for certain liquid financial assets that can be written up to reflect their fair market value ("FMV"), companies must carry the value of assets at their net historical cost. Under IFRS, the revaluation of PP&E to fair value is permitted. Even though permitted, it's not widely used and thus not even well known in the US. Don't voluntarily bring this up in an interview on your own. What is the difference between growth and maintenance capex? - ansGrowth Capex: The discretionary spending of a business to facilitate new growth plans, acquire more customers, and expand geographically. Throughout periods of economic expansion, growth capex tends to increase across most industries (and the reverse during an economic contraction). Maintenance Capex: The required expenditures for the business to continue operating in its current state (e.g., repair broken equipment). Which types of intangible assets are amortized? - ansAmortization is based on the same accounting concept as depreciation, except it applies to intangible assets rather than fixed tangible assets such as PP&E. Intangible assets include customer lists, copyrights, trademarks, and patents, which all have a finite life and are thus amortized over their useful life. What is goodwill and how is it created? - ansGoodwill represents an intangible asset that captures the excess of the purchase price over the fair market value of an acquired business's net assets. Suppose an acquirer buys a company for a $500 million purchase price with a fair market value of $450 million. In this hypothetical scenario, goodwill of $50 million would be recognized on the acquirer's balance sheet. Can companies amortize goodwill? - ansUnder GAAP, public companies are prohibited from amortizing goodwill as it's assumed to have an indefinite life, similar to land. Instead, goodwill must be tested annually for impairment. However, privately held companies may elect to amortize goodwill and under some circumstances, goodwill can be amortized over 15 years for tax reporting purposes. What is the "going concern" assumption used in accrual accounting? - ansIn accrual accounting, companies are assumed to continue operating into the foreseeable future and remain in existence indefinitely. The assumption has broad valuation implications, given the expectation of continued cash flow generation from the assets belonging to a company, as opposed to being liquidated. Explain the reasoning behind the principle of conservatism in accrual accounting. - ansThe conservatism principle requires thorough verification and use of caution by accountants when
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
preparing financial statements, which leads to a downward measurement bias in their estimates. Central to accounting conservatism is the belief that it's better to understate revenue or the value of assets than to overstate it (and the reverse for expenses and liabilities). As a result, the risk of a company's revenue or asset values being overstated, and expenses or liabilities being understated is minimized. Why are most assets recorded at their historical cost under accrual accounting? - ansThe historical cost principle states that an asset's value on the balance sheet must reflect the initial purchase price, not the current market value. This guideline represents the most consistent measurement method since there's no need for constant revaluations and markups, thereby reducing market volatility. What role did fair-value accounting have in the subprime mortgage crisis? - ansIn the worst- case scenario, sudden drops in asset values could cause a domino effect in the market. An example was the subprime mortgage crisis, in which the meltdown's catalyst is considered to be FAS-157. This mark-to-market accounting rule mandated financial institutions to update their pricing of illiquid securities. Soon after, write-downs in financial derivatives, most notably credit default swaps ("CDS") and mortgage-backed securities ("MBS"), ensued from commercial banks, and it was all downhill from there. Why are the values of a company's intangible assets not reflected on its balance sheet? - ansThe objectivity principle of accrual accounting states that only verifiable, unbiased data can be used in financial filings, as opposed to subjective measures. For this reason, internally developed intangible assets such as branding, trademarks, and intellectual property will have no value recorded on the balance sheet because they cannot be accurately quantified and recorded. Companies are not permitted to assign values to these intangible assets unless the value is readily observable in the market via acquisition. Since there's a confirmable purchase price, a portion of the excess amount paid can be allocated towards the rights of owning the intangible assets and recorded on the closing balance sheet. If the share price of a company increases by 10%, what is the balance sheet impact? - ansThere would no change on the balance sheet as shareholders' equity reflects the book value of equity. Equity value, also known as the "market capitalization," represents the value of a company's equity based on supply and demand in the open market. In contrast, the book value of equity is the initial historical amount shown on the balance sheet for accounting purposes. This represents the company's residual value belonging to equity shareholders once all of its assets are liquidated and liabilities are paid off. Book Value of Equity = Total Assets - Total Liabilities.
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
unfulfilled obligations to the customers that paid in advance, hence its classification as a liability. Accounts Receivable: A/R is an asset because the company has already delivered the goods/services and all that remains is the collection of payments from the customers that paid on credit. Why are increases in accounts payable shown as an increase in cash flow? - ansAn increase in accounts payable would mean the company has been delaying payments to its suppliers or vendors, and the cash is currently still in the company's possession. The due payments will eventually be made, but the cash belongs to the company for the time being and is not restricted from being used. Thus, an increase in accounts payable is reflected as an inflow of cash on the cash flow statement. Which section of the cash flow statement captures interest expense? - ansThe cash flow statement doesn't directly capture interest expense. However, interest expense is recognized on the income statement and then gets indirectly captured in the cash from operations section since net income is the starting line item on the cash flow statement. What happens to the three financial statements if a company initiates a dividend? - ansIS: When a company initiates a dividend, there'll be no changes to the income statement. However, a line below net income will state the dividend per share ("DPS") to show the amount paid. CFS: On the cash flow statement, the cash from financing section will decrease by the dividend payout amount and lower the ending cash balance at the bottom. BS: The cash balance will decline by the dividend amount on the balance sheet, and the offsetting entry will be a decrease in retained earnings since dividends come directly out of retained earnings. Do inventories get captured on the income statement? - ansThere is no inventory line item on the income statement, but it gets indirectly captured, if only partially, in cost of goods sold (or operating expenses). For a specific period, regardless of whether the associated inventory was purchased during the same period, COGS may reflect a portion of the inventory used up. The two other financial statements would be more useful for assessing inventory as the cash flow statement shows the year-over-year changes in inventory, while the balance sheet shows the beginning and end-of-period inventory balances. How should an increase in inventory get handled on the cash flow statement? - ansAn increase in inventory reflects a use of cash and should thus be reflected as an outflow on the cash from operations section of the cash flow statement. The inventory balance increasing
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
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Latest Updated Exam Study Guide 2025/
from the prior period implies the amount of inventory purchased exceeded the amount expensed on the income statement. What is the difference between LIFO and FIFO, and what are the implications on net income? - ansFIFO and LIFO are two inventory accounting methods to estimate the value of inventory sold in a period. First In, First Out ("FIFO"): Under FIFO accounting, the goods that were purchased earlier would be the first ones to be recognized and expensed on the income statement. Last In, First Out ("LIFO"): Alternatively, LIFO assumes that the most recently purchased inventories are recorded as the first ones to be sold first. The impact on net income would depend on how inventory costs have changed over time: Rising Inventory Costs - ansFirst In, First Out (FIFO) If inventory costs have been rising, lower COGS would be recorded under FIFO. Since the less expensive inventory was recognized, net income will be higher in the current period. Last In, First Out (LIFO) If inventory costs have been rising, then COGS for the period will be higher under LIFO because the recent, pricier purchases are assumed to be sold first. Thus, the result would be lower net income for the period. The impact on net income would depend on how inventory costs have changed over time: Decreasing Inventory Costs - ansIf inventory costs have been dropping, COGS would be higher under FIFO, since older inventory costs are more expensive. The ending result would be lower net income for the period. Last In, First Out (LIFO) If inventory costs have been dropping, then COGS would be lower under LIFO. Thereby, net income for the period will be higher since the cheaper inventory costs were recognized. What is the average cost method of inventory accounting? - ansBesides FIFO and LIFO, the average cost method is the third most widely used inventory accounting method. Under this method, the assigned inventory costs are based on a weighted average, in which the total
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
(10- K) and three quarterly (10-Q) reports each year. These reports are available for free through SEC EDGAR. In other countries, reporting requirements will vary, but most countries will require at least an annual report, while some will require an interim filing (i.e., a report in the middle of the company's fiscal year). Only a few countries make company filings easily accessible through a central database, forcing analysts to rely on expensive financial data providers or dig through company websites manually to collect data. The closest database to EDGAR in breadth and ease of use is Canada's SEDAR database. In the United Kingdom, the closest EDGAR equivalent is Companies House, where private companies must also report their financials. What is a proxy statement? - ansThe proxy statement, formally known as "Form 14A," is required to be filed before a shareholder meeting to solicit shareholder votes. The document must disclose all relevant details regarding the matter for shareholders to make an informed decision. In addition, the board of directors' compensation and other notable announcements such as changes to the company's articles of incorporation are included. What is an 8-K and when is it required to be filed? - ansAn 8-K is a required filing with the SEC when a company undergoes a materially significant event and must disclose the details. Often called the "current report," 8-Ks are usually filed within four days of the event. The information contained within the report should be of high importance and pertinent to shareholders. Events that would trigger this filing would include previously unannounced plans for a new acquisition, disposal of assets, bankruptcy, a tender offer, the resignation of a senior-level manager or member of the board of directors, or disclosure that the company is under SEC investigation for alleged wrongdoing. Why has understanding the differences between US GAAP and IFRS financial reporting become increasingly important? - ansFor public companies in the US, the reporting rules and guidelines are set by the Financial Accounting Standards Board (FASB) and referred to as US Generally Accepted Accounting Principles (US GAAP). The International Accounting Standards Board (IASB) oversees the International Financial Reporting Standards (IFRS), which is followed by over 144 countries. Understanding the differences between US GAAP and IFRS has become more important because:
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
Continuation of Globalization: Globalization is the gradual convergence of economies in different countries. The widespread adoption of IFRS has placed pressure on the US to adopt IFRS to have a single set of accounting standards and rules used worldwide, but it seems unlikely in the near-term. Geographic Diversification of Investments: In recent years, investment firms have been broadening their investments' geographic scope to consider more opportunities overseas. Nowadays, institutional investors are more open to making investments in emerging markets due to the prevalence of opportunities and as a strategy to re-risk their overall portfolio. Cross-Border M&A Activity: Cross-border mergers and acquisitions ("M&A") have emerged as a strategy for multinational companies to enter new markets, extend their reach to new potential customers, and diversify their revenue sources. What are some of the most common margins used to measure profitability? - ansGross Margin The percentage of revenue remaining after subtracting just COGS, the direct costs associated with the company's revenue generation (e.g., direct materials, direct labor). Gross Margin = Gross Profit Revenue Operating Margin The percentage of profitability after subtracting operating expenses from gross profit. This measure is useful for comparisons due to being independent of capital structure and taxes. Operating Margin = EBIT Revenue Net Profit Margin The percentage of accrual profitability remaining after all expenses have been subtracted. Unlike operating margin, this measure is impacted by capital structure and taxes. Net Profit Margin = Net Income Revenue EBITDA Margin The most widely used profit margin for benchmarking due to being independent of capital structure and taxes, in addition to adjusted for non-cash expenses (D&A) and non-recurring items. EBITDA Margin = EBITDA Revenue
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
focus is on continuously making operational improvements and bringing in revenue (e.g., set prices more appropriately post-market research, target right end markets). Inorganic Growth: Once the opportunities for organic growth have been maximized, a company may turn to inorganic growth, which refers to growth driven by M&A. Inorganic growth is often considered faster and more convenient than organic growth. Post-acquisition, a company can benefit from synergies, such as having new customers to sell to, bundling complementary products, and diversification in revenue. How does the relationship between depreciation and capex shift as companies mature? - ansThe more a company has spent on capex in recent years, the more depreciation the company incurs in the near-term future. Therefore, when looking at high-growth companies spending heavily on growth capex, their ratio between capex and annual depreciation will far exceed 1. For mature businesses experiencing stagnating or declining growth, this ratio converges near 1, as the only capex is related to routine maintenance capex (e.g., replace equipment, refurbish store layouts). What is working capital? - ansThe working capital metric measures a company's liquidity and ability to pay off its current obligations using its current assets. In general, the more current assets a company has relative to its current liabilities, the lower its liquidity risk. Current liabilities represent payments that a company needs to make within the year (e.g., accounts payable, accrued expenses), whereas current assets are resources that can be turned into cash within the year (e.g., accounts receivable, inventory). Working Capital = Current Assets − Current Liabilities Why are cash and debt excluded in the calculation of net working capital (NWC)? - ansIn practice, cash and other short-term investments (e.g., treasury bills, marketable securities, commercial paper) and any interest-bearing debt (e.g., loans, revolver, bonds) are excluded when calculating working capital because they're non-operational and don't directly generate revenue. Net Working Capital (NWC) = Operating Current Assets − Operating Current Liabilities Cash & cash equivalents are closer to investing activities since the company can earn a slight return (~0.25% to 1.5%) through interest income, whereas debt is classified as financing. Neither is operations-related, and both are thereby excluded in the calculation of NWC. Is negative working capital a bad signal about a company's health? - ansFurther context would be required, as negative working capital can be positive or negative. For instance, negative working capital can result from being efficient at collecting revenue, quick
Investment Banking Training Manual
Detailed investment banking guide covering
financial modelling, valuation techniques,
accounting, M&A, LBOs, and Excel-based case
studies, based on Wall Street Prep’s training
curriculum
Latest Updated Exam Study Guide 2025/
inventory turnover, and delaying payments to suppliers while efficiently investing excess cash into high-yield investments. However, the opposite could be true, and negative working capital could signify impending liquidity issues. Imagine a company that has mismanaged its cash and faces a high accounts payable balance coming due soon, with a low inventory balance that desperately needs replenishing and low levels of AR. This company would need to find external financing as early as possible to stay afloat. What does change in net working capital tell you about a company's cash flows? - ansThe change in net working capital is important because it gives you a sense of how much a company's cash flows will deviate from its accrual-based net income. Change in Net Working Capital = NWC Prior Period − NWC Current Period If a company's NWC has increased year-over-year, its operating assets have grown and/or its operating liabilities have shrunk from the prior year. Since an increase in an operating asset is a cash outflow, it should be intuitive why an increase in NWC means less cash flow for a company (and vice versa). What ratios would you look at to assess working capital management efficiency? - ansDays Inventory Held ("DIH") DIH measures the average number of days it takes for a company to sell off its inventory. Companies strive to minimize their DIH and sell their inventory as soon as possible. DIH = (Inventory / COGS) × 365 Days Days Sales Outstanding ("DSO") = DSO represents the average number of days it takes for a company to collect payments made on credit. Lower DSOs mean less time is needed to retrieve cash from sales made on credit. DSO = (AR / Revenue) × 365 Days Days Payable Outstanding ("DPO") DPO refers to the average number of days it takes for a company to pay back its suppliers. Higher DPOs indicate the company has more bargaining power over its suppliers. DPO = (AP / COGS) × 365 Days What is the cash conversion cycle? - ansThe cash conversion cycle ("CCC") measures the number of days it takes a company to convert its inventory into cash from sales. Therefore, a
