Common mistakes in modeling tests

The cash flow statement is one of the three most important financial reports used by companies, alongside the balance sheet and the income statement. It shows how actual cash flows develop within a business, so when and how much money flows in or out of the company. This provides direct insight into a company’s liquidity and its ability to meet financial obligations.Unlike the cash flow statement, the balance sheet and income statement are based on the accrual accounting principle. Under this approach, revenues and expenses are not recorded when cash changes hands but are instead assigned to the accounting period in which they are economically incurred.In contrast, the cash flow statement is based on actual cash movements, therefore serving as a powerful tool in financial analysis. By focusing on real cash flows, it enables analysts to cut through the complexity of accounting and assess whether a company is truly generating cash or rather burning it.What Is the Cash Flow Statement?The cash flow statement is a financial report that tracks how much cash a company received and spent during a specific period, typically a quarter or year. It answers the question: where did the money come from, and where did it go?So, it’s all about cash flows which are either inflows or outflows. Cash inflows refer to the money coming into the business from sources like customer payments, loan proceeds, or asset sales. Cash outflows show money leaving the company for expenses, loan repayments, equipment purchases, or dividend payments. What Are the Most Important Elements of the Cash Flow Statement? The cash flow statement organizes the inflows and outflows into three main categories. These are operating activities, investing activities, and financial activities. Operating Activities The operating cash flow section shows how much cash is being generated or used in running the business’s core operations or day-to-day activities. As such, this part tells us whether a business can generate positive cash flow from its primary operations, which is crucial for long-term sustainability.The cash inflows for operating activities include all money received from customers for the sale of goods and services. It also includes other income related to the core business such as royalties, fees, commissions, and cash refunds from suppliers. Cash outflows for the operating activities section include money paid to suppliers for inventory and services, salaries and wages, operating expenses like rent and utilities, interest on business loans, and income tax payments. Companies can present operating cash flows using either the direct or indirect method. The direct method lists the major categories of operating cash receipts and payments during the period. For example, it shows cash collected from customers, cash paid to suppliers, and cash paid for operating expenses as separate line items. It requires detailed information so it’s rarely used in practice.The indirect method starts with the net income reported on the income statement and adjusts it to arrive at the actual operating cash flow. The following factors are taken into account:Adding Back Non-Cash ExpensesAll expenses that did not involve an actual outflow of cash are added back to net income. These include, for example, depreciation, stock-based compensation, bad debt expenses, or impairment losses.Substracting Non-cash revenuesConversely, revenues that did not result in actual cash inflows are subtracted. This mainly applies to gains from the sale of assets, as these are reported under investing or financing activities.Changes in working capitalWorking capital changes occur when there's a timing difference between when revenue/expenses are recorded and when cash is actually received/paid.Receivables: When receivables increase, the company has delivered goods or services but has not yet received payment – the amount is subtracted from net income. When receivables decrease, it means customers have paid outstanding invoices – the corresponding amount is added to net income, as actual cash has now been received.Payables: When payables increase, the company has incurred expenses but has not yet paid them. Although the expense has already been recorded in the income statement, no cash has left the business. These unpaid invoices temporarily increase cash flow and are therefore added back to net income. If payables decrease, it means existing debts have been settled, so cash has flowed out of the business. This cash outflow is subtracted from net income during the calculation.The result of the indirect method is an adjusted operating cash flow, which shows how much cash the core business has actually generated – regardless of any accounting distortions.Investing Activities The investing cash flow section shows the money spent on and received from investments in long-term assets and securities. From these activities, you can tell how a company is investing in its future growth or selling off assets for cash.Cash inflows from investing activities include cash received from sale of property, plant, and equipment (PPE) and investments like stocks, bonds, or other investment securities. Other common sources of inflow here are receipt of principal from loans made to others, insurance proceeds from damaged assets, and cash from sale of subsidiaries or business units. The common sources of cash outflows for investing activities include cash spent on acquiring new machinery, buildings, or equipment, purchase of investments like stocks, bonds, or other securities, and loans made to others.Financial Activities Financing activities detail the cash flows related to raising or repaying capital, whether it’s through debt or equity. They show how a business funds its operations and growth outside of its regular course of business.The common cash inflows for financing activities are issuance of stock and borrowing either through loans or issuing bonds. Outflow sources include repayment of debt, dividends paid, and repurchase of stock. How to Read and Interpret the Cash Flow StatementAnalyzing and interpreting a cash flow statement effectively requires the ability to understand what the numbers on the report tell you about a company’s financial health and strategic direction.Start with the Big Picture.Start by looking at the net change in cash at the bottom of the statement. A positive number means the company has more cash at the end of the period while a negative number means it has less. However, this alone doesn't tell the whole story. A company might have increased its cash position by taking on massive debt, which could be problematic long-term.Analyze Section by Section.Proceed to break it down by section. For the operating activities, look at whether the cash flow is increasing, declining, or highly volatile. The ideal scenario is a positive and growing cash flow as it shows the company’s core business is generating cash. If there’s consistently negative cash flow from operations, it can signal trouble suggesting the business isn’t bringing in enough cash to sustain itself. You can also compare net income to operating cash flow. If operating cash flow is consistently much lower than net income, investigate why. Large increases in accounts receivable might indicate collection problems, while inventory build ups could suggest demand issues.For the investing section, pay attention to the outflows. They’re common here as companies invest in equipment, property, or acquisitions. Modest, regular outflows can mean healthy reinvestment. Red flags include large, repeated inflows from asset sales which may mean the company is selling off assets to cover short-term needs. That isn’t sustainable long-term.Then move to the financing cash flow section and look at the line items. Inflows mean the company is raising money, through loans or issuing shares, while outflows mean it’s paying off debt, buying back shares, or paying dividends. New companies often show inflows here, while mature companies usually have outflows as they return value to shareholders and pay down debt.Check for Consistency and Trends.Look at cash flows for several periods to spot patterns. Is operating cash flow consistently positive? Are investing outflows matched by growth in assets or revenue? You can also compare to peers. See how cash flow metrics stack up against similar companies in the same industry.Watch for Warning Signs.As you go through the cash flow, analyze whether there are red flags or warning signs such as:Positive net income but negative operating cash flow: This discrepancy can suggest aggressive revenue recognition, where sales are booked before the cash is actually collected, or poor collection of receivables, meaning customers are slow to pay. It might also reflect rising inventory levels, which tie up cash even if sales appear strong. Over time, this can lead to liquidity problems despite seemingly healthy profits.Negative cash flow in all sections (operating, investing, and financing):If all three sections show outflows, the company may be burning cash with no immediate inflow sources. This often points to a serious cash crunch and could mean the business will need to raise debt or equity soon just to keep operating. In extreme cases, it might be a sign of distress or even impending insolvency.Use Ratios and Metrics.There are a few ratios and metrics you can calculate from the cash flow statement to interpret the financial position of a company including:Free Cash Flow (FCF)Formula: Operating Cash Flow − Capital Expenditures (from investing activities)What it shows: This measures the cash left after funding necessary investments in the business (like equipment, technology, or facilities). Positive and growing FCF gives the company flexibility to pay down debt, pay dividends, repurchase shares, or pursue acquisitions. Consistently negative FCF can be acceptable for high-growth companies investing heavily, but it’s a concern if it persists without revenue growth.Cash Flow to Debt RatioFormula: Operating Cash Flow ÷ Total DebtWhat it shows: This indicates how many years of current operating cash flow it would take to repay all debt. Higher ratios suggest stronger debt-paying ability, while low or declining ratios can signal over-leverage and potential solvency issues. Lenders often monitor this ratio when assessing credit risk.Cash Flow to Current Liabilities RatioFormula: Operating Cash Flow ÷ Current LiabilitiesWhat it shows: This measures the ability to cover short-term obligations with cash generated from operations. A ratio below 1.0 can mean the company might struggle to meet near-term obligations without additional financing or asset sales.Operating Cash Flow to Net Income RatioFormula: Operating Cash Flow ÷ Net IncomeWhat it shows: This ratio highlights the quality of earnings. Ideally, it should be close to or above 1.0 over time, meaning reported profits are supported by real cash inflows. A consistently lower ratio can indicate earnings manipulation, aggressive accounting, or working capital problems. Common Interview Questions About the Cash Flow StatementMost interview questions about the cash flow statement focus on your understanding of its structure, components, and how various financial activities impact it. Here are common questions to help with your practice: 1. Walk me through the cash flow statement.The cash flow statement is a financial statement used to report the actual movement of money into and out of a business. It is divided into three main sections. Operating activities show cash from day-to-day business operations like sales and expenses. Investing activities capture cash spent on or received from long-term assets like equipment purchases or asset sales while financing activities reveal cash movements from debt, equity, and dividend transactions. Together, these three sections tell the complete story of how a company's cash position changed, providing crucial insights that profit figures alone cannot deliver.2. What is the difference between net income and cash flow?Net income is calculated using accrual accounting and includes non-cash items like depreciation and accounts payable/receivable changes. Cash flow shows the actual inflows and outflows of cash during a period. So, while net income can be positive, the company might have negative cash flow if, for instance, significant sales are on credit or there are large capital expenditures.3. How does a non-cash expense (e.g., depreciation) affect the cash flow statement?Depreciation is the gradual allocation of an asset’s cost over its useful life. For example, spreading the cost of machinery over several years instead of recording it all at once. It reduces net income because it is recorded as an expense, but no cash actually leaves the company. On the cash flow statement, depreciation appears under operating activities and is added back to net income so the statement reflects the actual cash generated from operations.4. Explain how transactions like equipment purchase or sale impact the cash flow statement.Purchasing equipment is recorded as a cash outflow under investing activities, since the company is spending cash to acquire a long-term asset. On the other hand, selling equipment results in a cash inflow in investing activities. Though any gain or loss from the sale affects net income, the actual cash received from the sale is shown separately in the cash flow statement.5. How are increases in accounts receivable or inventory shown in the cash flow statement?When accounts receivable increase, it means the company has made sales but has not yet collected the cash. When inventory increases, the company has spent cash to buy or produce goods that have not yet been sold. In both cases, cash is tied up and unavailable for other uses. On the cash flow statement, these increases appear in the operating activities section and are subtracted from net income to show the reduction in actual cash.6. Can a company survive with negative cash flow from operations if investing and financing sections are positive?A company can temporarily survive negative operating cash flow if it’s able to bring in cash from investing, like selling assets, or financing, like taking on debt or issuing shares. However, this isn’t sustainable long-term. Consistently negative operating cash flow usually points to underlying problems with the core business, and relying on outside funds can only last so long before issues arise.7. How can a company have profits but still face a cash shortage?This happens due to accrual accounting. Profits (net income) are recorded when revenues are earned, not when cash is collected. If sales are made on credit or if expenses are deferred, a company can show profits on paper but not actually have enough cash coming in to cover daily expenses, leading to a cash shortage.8. Why is free cash flow important, and how is it calculated?Free cash flow is important because it shows how much cash a company has left after covering capital expenditures needed to maintain or grow its assets. It represents the cash available for dividends, debt repayment, or reinvestment. It’s calculated as operating cash flow minus capital expenditures, usually found under investing activities.9. How would you assess the cash position of a company using the cash flow statement?Start by examining the net change in cash to determine whether the company’s cash balance is increasing or decreasing. Then assess whether operating activities are consistently generating positive cash flow, which typically indicates a healthy core business. Finally, review the investing and financing sections to understand how the company is funding its operations and whether it is investing for growth or relying on external financing.10. If a company has positive net income but negative cash flow from operations, what might that indicate?This often indicates issues like aggressive revenue recognition, poor cash collections, or rising receivables and inventory. It means the company is recording profits but isn’t actually collecting enough cash from its customers, which can be a warning sign about the quality of earnings or cash management.👉 In our case library, you’ll find plenty of practice cases and exercises focused on the cash flow statement – perfect for your finance interview prep!

An income statement, also known as a profit and loss statement (P&L), is one of the three primary financial statements alongside a balance sheet and cash flow statement. Together, they give a report of a company’s financial health and performance over a specific period. But the income statement is often the starting point for financial analysis and valuation work. So, as you prepare for finance interviews, you must master the income statement including what it is, its structure and purpose, key concepts and terminology, and effects of different transactions. This guide will cover all that plus the connection between the three statements and common interview questions about the income statement.  What Is the Income Statement? The income statement is a financial report that summarizes a company’s revenues, expenses, and profits over a particular period, typically a quarter or a year. The purpose of this report is to answer the question: “How much money did the company make or lose during this period?”As such, finance professionals, management, and investors use the income statement to assess a company’s ability to generate profit, manage costs, and sustain growth. Structure of the Income StatementThere are two common types of income statements: the single step and the multi step income statement. They differ in how detailed the revenues and expenses are presented.An income statement has three main sections: Revenue, Expenses, and Profit or Loss. If it’s expressed in a formula, the simplest form is:Revenue - Expenses = Net IncomeSome companies, especially small businesses, use this basic formula to create a single-step income statement. This format takes total revenue and subtracts the total expenses. It’s easy to understand but doesn't give you much detail about different types of income and expenses.The other structure is known as a multi-step income statement, and it’s common among large and public companies. The formula is still the same but the structure breaks everything down into stages. Instead of one big calculation, it shows you several smaller calculations that build on each other:Step 1: Revenue - Cost of Goods Sold = Gross ProfitStep 2: Gross Profit - Operating Expenses = Operating IncomeStep 3: Operating Income - Non-Operating Expenses = Net IncomeThis multi-step method helps to understand different aspects of the business. For instance, the gross profit tells you if the company is good at making and selling its products, operating income shows if the company runs its day-to-day operations efficiently, and net income tells you the final result after everything, including taxes and interest.  What Are the Most Important Elements in the Income Statement?From the overall structure, you can tell the most crucial elements of the income statement are revenue, costs of goods sold, gross profit, operating expenses, operating income, and net income. They are referred to as line items, and it’s important to understand what each means as well as how it affects the statement. Revenue (Top Line)This is all the money a company receives from selling its products or services. It's called the "top line" because it literally appears at the top of the income statement. A company can choose to break down revenue into different segments or product lines. This section must also follow accounting rules about when to count the sale, even if payment comes later.Cost of Goods Sold (COGS)These are the direct costs associated with producing the goods or services sold by the company. COGS includes materials, labor, and manufacturing overhead directly tied to production. For instance, the COGS for a car manufacturer could include steel, engines, and assembly line workers.Gross ProfitThe gross profit is calculated as revenue minus COGS. It shows how much money remains after covering direct production costs. So, it tells you how profitable the company's core products or business is before considering other costs. The figure is also used to calculate gross margin, which is gross profit divided by revenue. Gross margin is a key metric that analysts use to compare companies and assess pricing power and operational efficiency.Operating ExpensesThese are the costs of running the business that aren't directly tied to making products. They include selling expenses like advertising, general and administrative expenses (SG&A) like rent and salaries, research and development (R&D) funds, and depreciation and amortization. Operating expenses are useful in understanding a company's cost structure and management's ability to control costs while growing the business.Operating Income (EBIT)EBIT stands for Earnings Before Interest and Taxes. It represents the profit generated from core business operations, excluding financing and tax effects. This metric is particularly important for valuation purposes and comparing companies with different capital structures.Formula: Gross Profit - Operating Expenses = Operating IncomeInterest Expense and IncomeThese line items are also known as non-operating expenses and income. They are costs or losses and gains not related to the main business operations for instance:Interest expense: cost of borrowing moneyInterest income: money earned from investmentsOne-time charges: costs from closing a factory or settling a lawsuitNet Income (Bottom Line) This is the final profit or loss after all expenses, taxes, and other items. Essentially, it’s calculated as operating income minus interest and taxes. Once the net income is known, it’s used to calculate earnings per share (EPS) and is also the starting point for cash flow analysis.EPS = (Net Income – Preferred Dividends) ÷ Weighted Average Common Shares Outstanding How to Read and Interpret the Income StatementThe best way to read an income statement is to start from the top and work your way down, asking the right questions at each level. This top-down approach helps you understand not just how much profit a company makes, but also how it gets there. Each line reveals something important about the company’s business model, efficiency, and cost structure. By analyzing the statement step by step, you can uncover trends, assess performance, and spot potential red flags.Let’s walk through this process using NVIDIA’s actual financial data as a real-world example. By applying each step to a leading tech company, you’ll see how to interpret the income statement in context. This approach makes the structure and key takeaways easier to grasp.Step 1: Analyze Revenue Growth and ScaleThe first line item we should read and interpret is revenue or sale. As you look at the figure, compare it to prior periods to see if there’s growth, decline, or stagnation. Then you can evaluate why that’s the case.From NVIDIA's data, the total revenue was $130.50 billion in 2025, compared to $60.92 billion in 2024 and $26.97 billion in 2023. That’s an extraordinary growth of 114% from 2024 to 2025 and 126% from 2023 to 2024. So, what’s causing such explosive revenue growth at NVIDIA? A simple research would tell us the AI boom is driving demand for their graphics processing units. However, such rapid growth also raises questions about sustainability. Can they maintain this pace, and what happens when growth inevitably slows?Step 2: Examine Gross Profitability and EfficiencyNext, look at the relationship between revenue and cost of goods sold to understand the company's gross profitability. The question to ask here is: ”Is COGS rising faster or slower than revenue?” If it’s faster, that could hurt margins. Calculate the gross margin by dividing gross profit by revenue, and compare this metric across different time periods and against industry competitors. An improving gross margin over time suggests the company is becoming more efficient at producing its goods or has pricing power in the market.NVIDIA's cost of revenue was $32.64 billion against $130.50 billion in revenue, yielding a gross profit of $97.86 billion. That’s an impressive gross margin of 75% ($97.86B ÷ $130.50B). Comparing this to previous years shows gross margins of 73% in 2024 ($44.30B ÷ $60.92B) and 57% in 2023 ($15.36B ÷ $26.97B). This means their COGS is slower than revenue growth, which is perfect.Step 3: Evaluate Operating Leverage and Cost ControlFor this step, pay attention to the operating expense section because it reveals how well management controls costs while investing in growth. Ask questions like: Are expenses under control? Any unusual increases?For instance, NVIDIA's operating expenses were $16.41 billion in 2025, compared to $11.33 billion in 2024 and $9.78 billion in 2023. While these expenses are growing, they're growing much slower than revenue. Operating expenses were just 12.6% of revenue in 2025, down from 18.6% in 2024 and 36.3% in 2023. That’s operational leverage when a company grows revenue faster than costs. The fact that NVIDIA maintained relatively controlled expense growth while more than doubling revenue shows exceptional management execution and business model strength.Step 4: Analyze Core Operating PerformanceOperating income, or EBIT, is often considered the most important profitability metric because it shows how well the core business performs regardless of how it's financed or taxed. Calculate the operating margin by dividing operating income by revenue, and track this metric over time. A company with consistently improving operating margins is becoming more efficient and profitable in its core operations.NVIDIA's operating income reached $81.45 billion in 2025, representing an operating margin of 62.4%. This compares to $32.97 billion (54.1% margin) in 2024 and $5.58 billion (20.7% margin) in 2023. That’s a sign of a company operating at peak efficiency with strong competitive positioning.Step 5: Assess Financial Structure and Tax ManagementLastly, assess interest expenses and their relationship to the company's debt levels. High interest expenses relative to operating income might mean excessive leverage and financial risk. Similarly, examine the tax rate to ensure it's reasonable and consistent with expectations. Unusual tax rates might indicate one-time tax benefits or charges that could distort the true underlying profitability of the business.NVIDIA has net interest income of $1.54 billion, meaning they earn more from investments than they pay on debt. This suggests a strong balance sheet with excess cash rather than financial leverage concerns. Their tax provision of $11.15 billion on $84.03 billion in pretax income is an effective tax rate of 13.3%, which is reasonable for a multinational technology company utilizing various tax optimization strategies.Then of course you can tell from the net income whether the company made a profit or loss. Compare the figure to previous periods and competitors. For instance, a company might be profitable but weak compared to competitors, which could be due to strategic challenges. Common Interview Questions About the Income Statement Most interview questions about the income statement test whether you know what the report is all about. So, they’ll ask questions about definition and what happens if one or more items change. Interviewers also want to see if you understand how the income statement links to the balance sheet and cash flow statement. Here’s our selection of top questions to help you prepare for finance interviews. 1. Walk me through the income statement.The income statement summarizes a company’s revenues, expenses, and profits over a specific period, such as a quarter or year. A standard income statement starts with total revenue earned from sales or services, then subtracts the cost of goods sold (COGS) to arrive at gross profit. After that, operating expenses such as selling, general and administrative expenses (SG&A), depreciation, and amortization are deducted, resulting in operating income. Then, non-operating items like interest expense and taxes are subtracted to finally arrive at net income, which is the company’s profit over the period.2. Explain the three primary financial statements and their purposes.The main three financial statements are the Profit & Loss Statement (P&L), Balance Sheet, and Statement of Cash Flows.The P&L Statement tells us about a company’s profitability by subtracting expenses from revenue over a specific period. This gives the net profit or loss.The Balance Sheet is a summary of what the company owns (Assets) including cash, inventory, and fixed assets, what it owes (Liabilities) such as loans and accounts payable, and the owners' stake (Equity). The standard equation is: Assets = Liabilities + Equity.The Statement of Cash Flows starts with net profit from the income statement, makes adjustments for non-cash items and changes in working capital, then shows cash movements from operating, investing, and financing activities, resulting in the net change in cash position.3. What are the key line items you'd find on the income statement?Sales Revenue; Cost of Sales; Gross Margin; Operating Expenses (including R&D, Sales & Marketing); EBITDA; Interest Expense; Pre-tax Profit; Net Profit.4. If depreciation expense increases by $15, how would it affect the income statement?If depreciation expense increases by $15, it would reduce the operating income on the income statement by $15 because depreciation is recorded as an operating expense. This, in turn, lowers the pre-tax income, tax expense, and net income. 5. What happens to the income statement if accrued wages increase by $15?Accrued wages are recorded on the income statement as an expense, specifically under payroll or wage expenses. Ideally, the wage expense is recognized in the income statement for the period when the employees earned it, regardless of whether the cash has been disbursed.So, a $15 increase in accrued wages would lower the operating income and the net income for that period by $15 before tax effects.6. What is the difference between COGS and operating expenses (OpEx)?COGS are the direct costs associated with producing goods or delivering services, such as raw materials and labor directly involved in production. Operating expenses (OpEx), on the other hand, are indirect costs related to running the company's daily operations, such as marketing, administration, rent, and utilities. The primary difference is that COGS is tied directly to production, while OpEx covers broader operational costs.7. What are common profitability margins we get from the income statement?Gross Margin: (Gross Profit / Revenue): It shows the percentage of revenue left after covering COGS.Operating Margin: (Operating Income / Revenue): It indicates profitability after operating expenses.Net Margin: (Net Income / Revenue): This reflects overall profitability after all expenses and taxes.8. Why is the income statement important relative to other financial statements?The income statement is important because it shows a company’s profitability over a period, explaining how revenue is transformed into net income. While the balance sheet provides an overview of financial position, and the cash flow statement shows cash inflows and outflows, the income statement is the primary measure of operational success and business performance. Investors and management use it to assess growth, profitability, and operational efficiency.9. How does the income statement connect with the balance sheet and cash flow statement? The three financial statements are interconnected through net profit from the P&L. The net profit figure from the income statement is used in the retained earnings section on the Balance Sheet and serves as the starting point for the Cash Flow Statement.👉 Practice interview questions like these in our Case Library