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What the interviewer is testing
Basic accounting fluency: what each statement shows, the period versus point-in-time distinction, and, most importantly, how the statements link so the balance sheet balances.
Answer framework
- Income statement: revenue, expenses and net income over a period.
- Balance sheet: assets, liabilities and shareholders' equity at a point in time; assets equal liabilities plus equity.
- Cash flow statement: starts with net income, adjusts for non-cash items and working capital (operations), then adds investing and financing to give the net change in cash.
- Links: net income flows to the cash flow statement and, less dividends, into retained earnings; the net change in cash updates cash on the balance sheet.
Sample answer
The income statement shows revenue, expenses and net income over a period. The balance sheet shows assets, liabilities and shareholders' equity at a point in time, and assets must equal liabilities plus equity. The cash flow statement starts with net income, adjusts for non-cash items and changes in working capital to get cash flow from operations, then adds cash flow from investing and from financing to give the net change in cash.
They link like this: net income is the first line of the cash flow statement. Non-cash charges such as depreciation and changes in balance sheet working capital items adjust it to cash from operations; capex, debt and equity flows appear in investing and financing. The net change in cash updates cash on the balance sheet, and net income less dividends flows into retained earnings, which keeps the balance sheet balanced.
Likely follow-ups
Common mistakes
- Describing each statement but never explaining how they link.
- Mixing up period (income and cash flow statements) with point in time (balance sheet).
- Forgetting that net income flows into retained earnings.
- Starting the cash flow statement with revenue instead of net income.
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Related questions
Based on questions #1, #2 in the full question bank.