A lot of you must have started your preparation for JBIMS MSc Finance but considering the fact that this is a specialized course, your preparation needs to be Finance specific. This is not for the written test but for the personal interview stage where you will have an opportunity to show your interest and knowledge of Finance. It is not possible to be an expert in the next one month, but if you do these things, you will have a fair shot. In this series of articles, I am going to share concepts and expected questions.
In the interview, nobody will give you 10 transactions and ask you to prepare a P&L for the period or a balance sheet as on xyz date or a cash flow statement. But you must know what each of these mean (basic understanding). If you are a Commerce or a BMS student or have done anything related to Finance, you won’t find this part difficult. But you will have to go through some of these concepts again to avoid awkward situations in the interview. Most of the students end up making fundamental errors when given problems during interview and the best solution for that is identifying the kind of questions that can be asked and preparing accordingly.
1. Profit and loss account
A profit and loss statement (P&L) is a financial statement that summarizes the revenues, costs and expenses incurred during a specific period of time, usually a fiscal quarter or year. These records provide information about a company’s ability – or lack thereof – to generate profit by increasing revenue, reducing costs, or both. The P&L statement is also referred to as “statement of profit and loss”, “income statement,” “statement of operations,” “statement of financial results,” and “income and expense statement.”
The income statement begins with an entry for revenue, known as the “top line,” and subtracts the costs of doing business, including cost of goods sold, operating expenses, tax expense and interest expense. The difference, known as the bottom line, is net income, also referred to as profit or earnings. The income statement can be used to calculate a number of metrics, including the gross profit margin, the operating profit margin, the net profit margin and the operating ratio. Together with the balance sheet and cash flow statement, the income statement provides an in-depth look at a company’s financial performance and position. Watch this Video on P&L
2. Balance Sheet
A balance sheet is a financial statement that summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by shareholders. The balance sheet adheres to the following formula: Assets = Liabilities + Shareholders’ Equity
The balance sheets gets its name from the fact that the two sides of the equation above – assets on the one side and liabilities plus shareholders’ equity on the other – must balance out. This is intuitive: a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholders’ equity). The balance sheet is a snapshot, representing the state of a company’s finances at a moment in time. By itself, it cannot give a sense of the trends that are playing out over a longer period. For this reason, the balance sheet should be compared with those of previous periods. It should also be compared with those of other businesses in the same industry, since different industries have unique approaches to financing. A number of ratios can be derived from the balance sheet, helping investors get a sense of how healthy a company is. These include the debt-to-equity ratio and the acid-test ratio, along with many others. The income statement and statement of cash flows also provide valuable context for assessing a company’s finances, as do any notes or addenda in an earnings report that might refer back to the balance sheet. Watch this Video on Balance Sheet
3. Cash flow statement
A cash flow statement is one of the quarterly financial reports any publicly traded company is required to disclose. The document provides aggregate data regarding all cash inflows a company receives from both its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given quarter.
Because public companies tend to use accrual accounting, the income statements they release each quarter may not necessarily reflect changes in their cash positions. For example, if a company lands a major contract, this contract would be recognized as revenue (and therefore income), but the company may not yet actually receive the cash from the contract until a later date. While the company may be earning a profit in the eyes of accountants (and paying income taxes on it), the company may, during the quarter, actually end up with less cash than when it started the quarter. Even profitable companies can fail to adequately manage their cash flow, which is why the cash flow statement is important: it helps investors see if a company is having trouble with cash. Watch this Video on Cash flow statement
Debt is an amount of money borrowed by one party from another. Debt is used by many corporations and individuals as a method of making large purchases that they could not afford under normal circumstances. A debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest. Under the terms of a loan, the borrower is required to repay the balance of the loan by a certain date, typically several years in the future. The terms of the loan also stipulate the amount of interest that the borrower is required to pay annually, expressed as a percentage of the loan amount. Interest is used as a way to ensure that the lender is compensated for taking on the risk of the loan while also encouraging the borrower to repay the loan quickly in order to limit his total interest expense.
In corporate finance, there is a lot of attention paid to the amount of debt a company has. A company that has a large amount of debt may not be able to make its interest payments if sales drop, putting the business in danger of bankruptcy. Conversely, a company that uses no debt may be missing out on important expansion opportunities. Different industries use debt differently, so the “right” amount of debt varies from business to business. When assessing the financial standing of a give company, therefore, various metrics are used to determine if the level of debt, or leverage, the company uses to fund operations is within a healthy range. Watch this Video on debt
Equity is the value of an asset less the value of all liabilities on that asset. Equity = Assets – Liabilities
Yet, because of the variety of types of assets that exist, this simple definition can have somewhat different meanings when referring to different kinds of assets. The following are more specific definitions for the various forms of equity:
- A stock or any other security representing an ownership interest. This may be in a private company (not publicly traded), in which case it is called private equity.
- On a company’s balance sheet, the amount of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses). Also referred to as shareholders’ equity.
- In the context of margin trading, the value of securities in a margin account minus what has been borrowed from the brokerage.
- In the context of real estate, the difference between the current fair market value of the property and the amount the owner still owes on the mortgage. It is the amount that the owner would receive after selling a property and paying off the mortgage. Also referred to as “real property value.”
- In terms of investment strategies, equity (stocks) is one of the principal asset classes. The other two are fixed-income (bonds) and cash/cash-equivalents. These are used in asset allocation planning to structure a desired risk and return profile for an investor’s portfolio.
- When a business goes bankrupt and has to liquidate, the amount of money remaining (if any) after the business repays its creditors. This is most often called “ownership equity” but is also referred to as risk capital or “liable capital.”
The term’s meaning depends very much on the context. In finance in general, you can think of equity as one’s ownership in any asset after all debts associated with that asset are paid off. Watch this Video on Equity
Hope you found this useful. Stay tuned for more Finance concepts and supercharge your MSc Finance interview preparation. Contact us in case of any queries and join our Facebook preparation group! And take our Free MSc Finance mock today!