Top Finance Interview Questions and Answers

Through this article, we will discuss the most asked finance interview questions that you must be aware of. Let us get started with the article.

Finance interview questions will help you in preparing for every finance-related job profile. These questions will cover accounting, financial markets, ratios and other important concepts. Let us get started with the questions.

Table of Contents

• Finance Interview Questions

Most Asked Finance Interview Questions

Let us discuss some of the most asked finance interview questions in this section.

Q1. What will be the impact of an asset purchase on the balance sheet and income statement?

Ans. When an asset is purchased, it is not reported on the income statement initially. At first, it is reported in the balance sheet. This is reported as an increase in the fixed assets line item. Asset side increases. Liabilities and Owner’s Equity side will also increase since Accounts Payable is a liability.

Q2. How are the three main financial statements linked to one another?

Ans. The three main financial statements are linked to each other in the following ways:

1. Net income from income statement flows to balance sheet and cash flow statement.
2. Depreciation is added back and the CapEx is deducted on cash flow statement, that determines PP&E on balance sheet.
3. Financing activities affect balance sheet and cash from finalizing. Interest is shown on the income statement.
4. Sum of the closing cash balance of last period and the cash of this period from operations, financing and investing is the closing cash balance on the balance sheet.

Q3. Why do companies prefer to fund their operations by issuing equity instead of debt?

Ans. Let us discuss the reasons why companies prefer to fund their operations through equity:

1. Companies do not need to pay back the money generated through equity financing. It is an investment in the company. The investor seeks returns from the equity in the company.
2. There is no fixed financial charge in case of equity. In debt financing, companies have to agree to a fixed rate of return, in addition to the principal. The company will have to pay the finance charge to debtors. For equity, companies can choose not to pay dividends as per their performance over the past year. 
3. In case of equity, company does not need to present collaterals. While raising finance through debt financing, companies need to present collaterals. 
4. In debt financing, cash flows away from the business once the finance is raised whereas in equity financing no cash flows away from the business.
5. The option for debt financing is available to companies based on their credit history. If a  business does not have a good credit rating, financial institutions may be reluctant to lend money to such a company. Equity financing does not account for the past credit rating of the company. 

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Q4. Explain the types of short term financing that companies may opt for to fulfil cash requirements?

Ans. Short-term financing is for loans within one year. Trade credit, bank loans and commercial paper are some ways of short term financing.

1. Trade credit: This is the largest category of short term credit. In this, the company buys its supplies from other companies thus recording the debt as account payable. Credit terms are expressed with a discount for faster payment. For example, if a seller makes payment within a week of the invoice date, he will be allowed with 2.5% cash discount. If the seller does no take the cash discount, payment will be due in 30 days after the date of invoice. The price of the credit is not taking cash discounts.

2. Bank loans: These are the second most opted ways of short term financing that appears as notes payable on balance sheet. Organizations have to sign a promissory note. An understanding between the bank and organisation is there on how much loan can be provided at a time.

3. Commercial paper: It consists of reputed firms’ promissory notes sold to insurance companies, pension funds, businesses and banks. These are issued for two to six months. The rates on prime commercial paper may vary, but they are below the rates that is paid on prime business loans. 

This short term financing has a limitation. Its resources are limited to the excess liquidity that corporations and main fund suppliers have at any particular time. 

Q5. Why do businesses use DCF method?

Ans. This is one of the important finance interview questions. Discounted cash flow (DCF) is a valuation method that determines investment value based on future cash flows. Basically, it helps in calculating the current worth of the investment based on future returns. 

Analysts may apply discounts in DCF analysis for lack of liquidity, small company risk and shares that represent minority interest. Company owners can use DCF analysis for both investments and asset purchases. It is a blue ribbon standard for the valuation of privately held companies.

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Q6. State some disadvantages of the double entry system?

Ans. In a double entry system, it is a little difficult to find errors when transactions are recorded in books. If an error is detective, then extensive clerical labor will be required. If the information is not recorded in journal, you cannot disclose that transaction-related information.

Q7. What are the different business valuation methods?

Ans. Following are some of the important business valuation methods:

1. Market capitalization: This is the simplest method for business valuation. For this, the share price of the company is multiplied by total number of outstanding shares.
2. Earning multiplier: It provides the real value of company with accuracy. It compares the relative stock costliness of similar companies. It adjusts future profits that can be invested at current rate of interest over same time period. 
3. Times revenue: Stream of revenues that are generated over a period of time is applied to multiplier that depends on the industry.
4. Liquidation value: This indicates the net cash that the company will recieve today if its assets are liquidated and liabilities are paid off. 
5. DCF: It provided future cash flow projections that are adjusted to find out the current market value of your business. This method uses inflation to find the current value.

Q8. When do businesses capitalize a purchase?

Ans. The cost of an item is capitalized if its consumption period is longer. This will prevent the depreciation of its economic value. 

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Q9. Which statement will be used if a business can only use one statement to review its overall financial health?

Ans. This is a trick financial interview question since it is meant to assess your knowledge on financial statements. The statement of cash flows can be used since it indicates the actual cash that the company is generating.

Q10. Which one is cheaper, between debt or equity?

Ans. Debt is cheaper since it is paid before equity. It also has collateral backing. On the basis of business liquidation, debt ranks ahead of equity. 

Q11. Explain the rule of 72 in finance?

Ans. Rule of 72 is a numerical concept to predicts the time reqired for an investment to get double in worth. You need to multiply 72 by the annual interest that is generated on your savings to determine the time required for investments to increase by 100%

Q12. What are the methods of cash flow statement?

Ans. There are two methods of cash flow statement: direct and indirect methods. In the direct method, operating cash flows are displayed as a list of ingoing and outgoing cash flows. It deducts the money that you spend from the money received. In the indirect method, operating cash flows are presented as a reconciliation from profit to cash flow.

Q13. How can you calculate positive cash flow?

Ans. To calculate positive cash flows, you will have to determine the gross rental income which means you calculate how much to chare for rent. Add any other income to it. Once you do this, deduct operating expenses(everyday expenses and recurring cost) from your gross rental income. 

This will help you to estimate how much of the positive cash flow have to pay lenders. After this, you will deduct your capital expenses(CapEx), financing costs and taxable rental income. 

Cash Flow = Gross Rental Income – Operating Expenses – Capital Expenses – Financing Costs – Taxes

Q14. What does negative working capital indicate?

Ans. This is one of the direct finance interview questions. Negative working capital indicates efficiency in businesses that have low inventory and accounts receivable. For other businesses, negative working capital may indicate financial trouble since the business does not have sufficient cash to pay back its current liabilities.

Q15. Can a company have positive net income but still go bankrupt?

Ans: Yes, it is possible that a company has positive net income while it is going bankrupt. This can happen due to deteriorating working capital i.e. by increasing accounts receivable and reducing accounts payable.

Q16. Is it possible for a company to show positive cash flows while facing financial problems?

Ans: Yes, it is possible for a company to show positive cash flows while facing financial trouble through impractical enhancements in the working capital such as delaying payables and selling inventory. They can also show positive cash flow by not allowing revenue to go forward in the pipeline.

Q17. Why do we need to pass adjustment entries?

Ans: We pass adjustment entries to indicate the accurate profit and loss in ‘profits and loss’ accounts so that the accuracy of the balance sheet is maintained. 

In the absence of adjustment entries, the final statements will reflect incorrect information that may lead to error and confusion. The balance sheet will be unable to show the accurate position of the business.

Q18. Why does an increase in accounts receivable indicative of cash reduction in the cash flow statement?

Ans: We need to adjust net income to reflect an increase in the accounts receivable since the company actually did not receive the funds. As the cash flow statement begins with the net income, it indicates a cash reduction.

Q19. What types of stocks should be issued for a startup?

Ans: Financial markets are also a part of finance interview questions.  Let us try to answer this question. 

A startup has more risk when compared with a well-established organisation. For startups, stocks that protect the downside of equity holders and give them upside are recommended. These may include common stocks, preferred stock and debt notes with warrants.

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Q20. Define retained earnings?

Ans: Retained earnings refer to the profit or surplus money that can either be reinvested in the business or paid as dividends to the shareholders.  

Q21. What is the difference between budgeting and forecasting?

Ans: Following are the differences between budgeting and forecasting:

1. Budgeting uses estimation for quantifying the desired levels of profits, cash flow and revenues that the business wants to achieve in future. On the other hand, financial forecasting estimates the revenue amount that will be achieved.
2. Budgeting reflects the desire of a business to reach somewhere whereas financial forecasting indicates the business direction as per the current situation.

Q22. What is swap?

Ans. Swap is an agreement between two parties for exchanging sequences of cash flows for a set time period. At the time when the contract is initiated, one of these series of cash flows is determined using random variables. 

These may be foreign exchange rate, an interest rate, equity or commodity price. Swap may be seen as either portfolio of forwarding contracts or aslong position in one bond that is coupled with a short position in another bond. 

Q23. How do you record PP&E?

Ans. For businesses, PP&E is one of the main capital assets that generate profitability, revenue and cash flow. While considering this, we must pay attention to four areas on the balance sheet: 

•  initial purchase
•  depreciation
• additions (capital expenditures)
• dispositions

You may also consider revaluation.

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Q24. How does inventory write-down affect financial statements?

Ans. This is one of the class finance interview questions. On the balance sheet, the asset account of inventory is decreased by the amount of the write-down as well as the shareholders’ equity. The income statement is hit with the expense in either cost of goods sold (COGS) or a separate line item for the amount of write-down. This leads to a reduction in net income. On a cash flow statement, a write-down is added back to cash from the operating activities since it’s a non-cash expense.

Q25. What are the reasons behind the merger of the two companies?  

Ans. Following reasons lead to the merger of companies:

1. If they want to have cost savings ie. to achieve synergies
2. The business wants to enter new markets
3. They want to acquire new technology
4. There is a common aim to get ahead of competitors.

These are some of the most asked finance interview questions. Do note that most interviewers ask application-based questions. It is important to develop a deep understanding of financial concepts so that you are able to answer everything.

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